Dollar Plunge Relentless But Gloom May Be Overdone
After spending a few days at the start of the week consolidating its losses around the 1.40 level, the greenback pushed lower still under the relentless threat of further rate cuts by the Fed and growing fears of a potential recession in the US economy. By the end of Friday EURUSD set yet another record high at 1.4275 and appeared destined to move higher.

The economic data was weak across the board, starting with a very ugly consumer confidence number which plunged below the key psychological level of 100 printing at 99.8 for the first time in 2 years. Durable goods was also of little help contracting another 4.9% on the month while housing continued to be a slow motion wreck with Existing Homes sales falling –8.3% against expectations of a -5.2% decline.

Nevertheless, despite the gloom and doom that has pervaded the markets the dollar bears may be overplaying their hand. As we noted on Thursday, “The low readings in consumer sentiment and the worse then expected drop in Durable Goods …all suggest that the economy is retrenching. However, the calls for an inevitable recession may be a bit premature, especially if labor markets remain steady. “ Indeed if there is any morsel of hope for greenback longs it rests on the surprisingly strong labor data This weeks jobless claims showed a marked improvement dropping below 300K and if NFPs rebound as expected to 100K they will demonstrate that US economy continues to expand suggesting that the calls of an imminent recession are overblown. while the path of least resistance is down, the dollar remains grossly oversold, and a better than expected NFP print could bring some temporary relief to downtrodden dollar longs.

Euro - Not All is Well on the EZ Front
“Le super-euro”. That’s what the French are calling it these days. And from the look of the price action who could disagree. The currency has set record highs three weeks in a row reaching 1.4275 in Friday trade. Meanwhile the retail exchange rates have actually reached 1.55 making each dollar worth only 2/3rd of a euro to any American tourist venturing abroad.

Yet the economic data within the region hardly supports such bullish sentiment. Both GFK consumer confidence and IFO business survey printed worse than forecast at 6.8 and 104.9 respectively while Industrial Orders contracted a sharp –4.0%. The Manufacturing data was for two months back, suggesting that the Industrial sector was already feeling the pinch with EURUSD in the high 1.30’s. With the pair now trading above 1.40 manufacturing may really begin to suffer as the competitive disadvantage of the high euro will pressure the exporters.

One interesting point to note is that EZ is the dominant exporter to the Middle East, which remains a dollar block region. Despite the record high oil revenues, the rise in the EURUSD exchange rate has wreaked havoc with inflation in the Gulf region and its demand for European goods may be curtailed, hurting EZ export growth.

Next week the marquee event will be the ECB rate announcement on Thursday. The market expects rates to remain at 4.0% and given the rise in the currency that outcome appears likely. Yet one of the assumptions underlying the euro’s recent rise has been the notion that the ECB has not reached the end of its tightening cycle. While ECB President Jean Claude Trichet is well know for never giving any forward guidance, show he not mention the word “vigilance” it would suggest that the ECB will remain stationary for the rest of the year. The realization that European rates aren’t rising anytime soon, may trigger a profit taking rally in the pair especially after such a parabolic rise over the past month.

Strong Yen Data Comes With Fine Print
The yen drifted within its broad range against the benchmark dollar for yet again last week. On the data front, the newswires were actually lit up by a number of top tier indicators; but most of these market-movers came with strings attached. The heavy economic flow came on Friday with fundamental traders working with inflation, spending and industrial production numbers among others. Retail sales and household spending data was among the most dramatically changed with household consumption rising a greater than expected 1.6 percent through August. This in turn helped boost the value of receipts over the same period by 3.9 percent– the single largest monthly increase in the indicator’s series in at least seven years. However, before hailing the return of a strong consumer appetite, we have to remember that a sizable rebound was suspected after poor weather and earthquakes in July severely depressed spending. Factories activity similarly saw an abnormal rebound in activity as many were able to resume production halted by the latter natural disaster. Alternatively, the inflation data grounded the currency with more consistent readings. The annual calculation on the core National CPI report marked its eighth consecutive negative number, grounding traders in the reality that the BoJ has little support for another rate hike for some time.

Outside the realm of the tidy economic calendar, risk trends continue to loosen their grip on the Japanese currency. Since credit markets seized and global equities collapsed in the first half of August, major stock indices have quickly closed back in on record highs and the carry trade has come back into vogue among the crosses. As testament to the robustness of the renewed appetite for risk, the yen hardly flinched when Yasuo Fukuda assumed the office of the Prime Minister from a battered Shinzo Abe. Though we have yet to see the full details on his plans for the economy, trade and his standpoint on the yen, he already enjoys a sizable approval rating.

In the days ahead, the calendar will release very few market-worthy indicators and those will be issued very early in the week. The Tankan report from the Bank of Japan will offer an outlook for business sector activity and spending. Taking into account firms’ persistent habit of competing with discounts, the threat of waning demand from the US and recent credit and lending issues, economists expect the more pertinent components of the report to pull back from 16-year highs. The outlook for manufacturing and services, as well as the planned capital expenditure figure, will be the stand out numbers. Not two hours later, the labor cash earnings report for August, will turn once again to the consumer. And, unlike last week’s spending data, this figure is not expected to be influenced by anomalous circumstances.

Pound Rallies Despite Financial Woes – Retrace Seems Likely
Signs that the UK financial system may be wavering were offset by upward revisions to GDP figures, allowing the British Pound to regain traction and leaving GBPUSD to end the week 1.3 percent higher at 2.0471. On Tuesday, the UK Telegraph reported that the Bank of England had only 4.4 million pounds to cover UK bank deposits in the case of a failure compared the $49 billion held by the FDIC in the US. However, this information is somewhat distorted, as the policies in the UK and the US are very different. The FSCS, which is the UK version of the FDIC, holds no funds and only raises those funds in the event of a bank failure, while on the other hand, the US has the money readily available in case of a collapse. This signals that things in the UK are not as bad as the article suggests, however, concerns were only exacerbated by news that struggling mortgage lender Northern Rock – which faced a customer bank run less than two weeks ago – had borrowed another 5 billion pounds, bringing the company's debt to the Bank of England up to nearly 8 billion pounds since it sought emergency funding two weeks ago. No other financial institutions have come out of the woodwork quite yet to seek funding, and unless there are banks in absolute dire straits, they probably won’t as this is equivalent to shouting “we’re in big trouble” to the financial press.

Over the course of this week, event risk in the UK will be scattered with the most market-moving data coming at the end of the week. First, traders may ignore PMI manufacturing on Monday to focus on housing equity withdrawals for the second quarter, as a marked drop-off could signal a decline in consumer spending. The release of PMI construction may go unnoticed, as the figure remains at very lofty levels and a mild decline in the figure would not be surprising. Finally, the BOE rate decision will garner the most attention, despite the fact that no rate change is expected. Given the woes of mortgage lender Northern Rock and fears that a credit crunch will disturb economic growth in the UK, speculation has risen that the BOE will cut rates this year. Nevertheless, BOE Governor Mervyn King remains an ardent inflation hawk and with housing prices, energy prices, and RPI still high, his bias is unlikely to change. Furthermore, King is notorious for being against the implementation of policies that have even the smallest chance of introducing the risk of moral hazard. As a result, we do not expect the BOE to cut rates in 2007. This may not translate into gains for GBPUSD this week, however, as the pair’s rally may be overextended.

USD/CHF Could Make Up Gains Despite An Expected Rise In CPI
The Swiss Franc set fresh multi-year highs against the downtrodden US dollar, with improved interest rate differentials boosting the Swissie’s stance against the greenback. Given the Fed’s surprise decision to cut interest rates by 50 basis points on September 18th and mounting speculation that the central bank will cut again in October, traders remain focused on the dollar’s narrowing yield advantage over the CHF. The US dollar is expected to fall further through the medium term, as clear expectations for further interest rate cuts can only worsen the buck’s stance across the board. In contrast, the Swiss Franc’s yield curve shows steadily rising rate expectations through the period. Fundamental data somewhat supported the currency’s gains, as the KOF index – a composite of major economic various economic indicators used to project growth in the coming three to six months - unexpectedly hit a 13-month high of 2.14 against expectations of a second monthly contraction to 2.00. Despite the fact that consumer sentiment has fallen in recent months amidst rising energy prices and a credit market upheaval, spending continued to fuel growth last month. What's more, business sector activity and trade account figures are still well balanced in positive territory. However, a feeling of caution is still hovering over the outlook on the Swiss economy. Should credit market disruptions upset employment trends or demand from a major trade partner like the Euro-zone cool, Swiss expansion may be in jeopardy. Nevertheless, the Swiss National Bank’s projections for steady, strong growth appear to be coming to fruition and could set the stage for continued rate normalization in December.

This week, event risk will be thin for the Swiss Franc, but the indicators due to be released could be market-moving on a very short-term basis. On October 1st, SVME PMI is likely to decline after the index surprisingly surged to a reading of 65.1 the month prior. Nevertheless, focus will be on the next day’s release, as CPI is scheduled to be announced. Inflation pressures remain very tepid, but a surprise jump could be enough to lead investors to ramp up speculation of a hike by the SNB in December. However, last week’s COT report showed that speculators are the longest they have been since June 2006, when USDCHF bottomed just below 1.20. As our Technical Strategist Jamie Saettele said in the report, “If speculators return to a net short position, then it is likely that a significant low is in place,” and this overextended positioning may be enough to force a short-term retrace in the USDCHF.

New Record High For Canadian Dollar
When liquidity flushed back into the FX market last week, fundamental traders had no economic data to work with but it did have a very heavy psychological burden attached to it after testing parity just before the weekend. As the US dollar stabilized and loonie traders bided their time until Friday’s GDP report, some of the perpetual bulls looked to take a little profit out of their successful USDCAD trades - and perhaps clear a little head room for continuation. A steady rebound in USDCAD held through Wednesday morning, carrying the pair all the way back to 1.0095 before the market tides changed. The turn in price action did no not come on its own. Crude oil, which had spent three days pulling back from its all time highs (lined up exactly with the USDCAD turn), before Wednesday rolled around with a strong rally from the closely monitored commodity. In three day’s the active WTI contract sprinted more than $5 to come within a few cents of the September 20th record. The bond between the oil and the Canadian currency was so strong that It even helped overcome a spat of disappointing economic data. Though the GDP number that crossed the wires Friday morning was only a monthly number, the series has a history of stoking volatility. Indeed, a 0.2 percent print from the July report did rouse price action; but the loonie rally was not the expected outcome from a release that fell short of economists forecasts for a 0.3 percent read. Regardless of the divergence of expectations, the economy continues to steam ahead at a healthy pace.

So will the crude correlation continue to drive the Canadian currency unimpeded next week? It may very well, but it will certainly have competition. The economic calendar is dotted with a number of top tier market movers. Coming late in the week Thursday starts the fundamental run with a building permits and Ivey PMI report. Building permits will act as leading indicator for the health of the housing market. So far, the residential market has shown little consequence of the recent credit freeze that has roiled markets around the world. However, it is too early to fully assess whether Canadians have successfully avoided this disruption or not. A little later that same day, the Ivey report for September will reveal whether heightened demand for commodities will counteract the taxing exchange rate. The market is looking for a higher number; and even if we do see one, this delicate balance cannot last for ever. Finally, Friday’s employment report will offer the greatest chance for a loonie-side reactions.

While the Canadian calendar may have its hand in moving the currency, a number of outside factors should be monitored as they could shock the market into motion. While Canadian credit market issues and political jawboning may drift in the background; US data could have a very real impact on USDCAD. NFPs, which reported its first contraction in three years last month, will be the loaded release.

Australian Dollar Surges on Gold Prices, but Can RBA Deliver on Rates?
The Australian dollar finished the week at fresh 18-year highs, boosted by a tumble in its US namesake and a surge in demand for high-yielding currencies. Marginally better-than-expected economic data kept the currency’s medium term rally intact, with similarly high-flying gold prices improving demand for the Aussie. The precious commodity rose on extended US dollar weakness and otherwise robust international demand—leaving little scope for a significant retracement of its recent advances. The correlation between the Australian dollar and Gold has reached its highest levels since mid-2006 and tells us that the AUD will continue to mirror moves in the precious metal.

Economic data on the week painted an optimistic view of future AUD price action, with the TD Securities Inflation indicator improving the odds for higher Australian interest rates through 2007. The private survey showed that the headline consumer prices rate matched previous multi-month highs of 3.0 percent through August. If the more closely-followed official CPI figure follows suit, then the inflation-targeting Reserve Bank of Australia will have little choice but to raise interest rates through subsequent meetings. An upcoming RBA meeting is sure to force volatility across AUD pairs, but markets doubt that the bank will raise rates on its October 3 meeting.

The RBA Cash Target announcement will clearly dominate event risk on the Australian dollar calendar, but later Retail Sales and Trade Balance figures likewise threaten extended moves in the domestic currency. A recent Bloomberg News survey shows that 27 of 27 economists expect the Reserve Bank to leave rates at 6.50 percent due to uncertainty in global credit markets. Yet an impressive AUD rally suggests that some expect RBA Governor Glenn Stevens to act on strong consumption data and send rates higher. Inaction by the bank would likely lead to a short-term Australian Dollar decline, but subsequent Retail Sales and Trade figures will undoubtedly force further volatility in AUD pairs. Retail consumption is expected to have decelerated in August, but a robust trend nonetheless shows warning signs of extended consumer spending. A simultaneous Trade Balance report is likewise expected to show a deterioration through August, but strong domestic commodity prices could nonetheless bolster Australian exports.

New Zealand Dollar Rallies on Strong Carry Trade Rebound
The New Zealand dollar surged to fresh monthly highs against its US namesake, bolstered by greenback weakness and robust demand for high-yielding currencies. The Kiwi’s 8.00 percent yield proved too difficult to resist, as speculators continued to pile onto NZDUSD longs. The previously beleaguered currency has shown clear signs of strength, with recent CFTC speculative positioning figures showing strong potential for a continuation in the NZD uptrend. Net non-commercial long positions grew by 1,600 contracts to 12,722 in the trade session ending September 25. The number showed clear improvement yet remains significantly below previous extremes—suggesting that further growth can only continue the Kiwi rally.

The week’s economic data likewise supported NZD bulls, with the key Gross Domestic Product figure showing above-consensus growth through the second quarter. Though the number comes on a significant 3-month lag, it shows that the economy remains more robust than previously imagined—diminishing the likelihood of Reserve Bank of New Zealand interest rate cuts through 2007. Consumer and Business confidence data likewise improved optimism on the state of the domestic economy. Indeed, the larger-than-expected Trade Balance deficit represented the only notable disappointment on the week of key economic data.

The coming days of event risk will be considerably more tame, with a second-tier ANZ Commodity Prices report the only notable on the ledger. Markets expect that strong Dairy and Food prices will boost the prices release, as robust global demand for soft agricultural goods continues to boost the Kiwi economy. Whether or not such a result will have an impact on the domestic currency is entirely another question. Indeed, the currency is likely to trade off of global risk sentiment and events in the neighboring Australian economy.

Boris Schlossberg is a Senior Currency Strategist at FXCM.