Dollar: Recession Postponed
While Friday’s strong NFP report may not have definitively stopped speculation about a US recession, it certainly postponed its oncoming anytime soon. The labor data revealed that despite turbulence in capital markets, Main Street fared relatively well. In September US jobs grew by 100K and more importantly the reports for August and July were revised upward by a total of 118K jobs suggesting that growth may have slowed but not ceased.

The dollar initially gained on all the majors as EUR/USD plunged in a knew jerk fashion, but the move was quickly reversed and the pair traded back above the 1.4150 level. There was talk in the markets of large buyers from Europe and Middle East at Friday lows. Certainly the 1.4030 level must have looked good to euro bulls who were looking to buy on the retrace back to the 1.40 figure. Furthermore, the good US employment number reignited risk appetite in the currency market driving all the high yielders yen crosses higher and taking the euro up in the process.

Still the rally in the EUR/USD is clearly overdone and the pair looks like its in the process of setting a double top. The commentary from Fed officials suggests that the Fed may now hold at the October meeting, and that fact should cap dollar weakness for the time being. Next week the key report will come on Friday as markets will focus on the Retail Sales data. If the consumer can remain resilient in the face of the housing fiasco and rising energy costs then the greenback may be able to finally put in a near term bottom.

Euro – Trichet Gives No Ground
As expected the ECB kept rates on hold at 4%, but in the post-announcement press conference the ECB chief was surprisingly hawkish. As we noted on Friday, “Unlike the Fed which focuses on core inflation readings (such as energy and food), the ECB chief made an overt reference to the headline CPI numbers, stating specifically that he expected to see them increase above the 2% rate that the central bank targets. Mr. Trichet’s pointed focus on inflation suggests that he has not abandoned the idea of one more rate hike in this tightening cycle, but under current conditions we continue to doubt that the ECB will make any further moves for the rest of the year, especially if the EZ PMI readings extend their decline in the next few months.”

Other data this week hardly proved supportive for the euro with Retail Sales rising far less than projected while PPI remained subdued at 0.1%. Nevertheless, the euro is now trading on pure momentum alone and, as was seen on Friday, the 1.40 figure was just too tempting for many buyers who missed the units earlier rise to all-time highs. Nevertheless, with little fundamental news to propel it higher, euro primary source of strength will remain its status as the anti-dollar. With the high cost of currency clearly impacting the EZ economies we wonder just how long the politicians in the region will tolerate the move before pressuring the monetary authorities to act.

USD/JPY May Push to 118.00 as BOJ Unlikely to Hike
As we’ve come to expect and experience in the forex markets time and time again, the Japanese Yen was unresponsive to strong economic data and instead continued on with its losing ways as carry trades started to pick up pace. Indeed, the Yen crosses such as GBP/JPY and EUR/JPY received their biggest boost on Friday as US equities rallied to new record highs on the back of a stronger-than-expected US non-farm payrolls report. Looking at the fundamental reports out of Japan, the Bank of Japan’s Tankan survey printed better than forecast at 23 versus consensus expectations of 21 as the credit crunch conditions that have impacted US and European markets appear to have had little negative impact on Japanese manufacturers. Although the outlook component drifted down to 19, offsetting some of the positive effects of the headline number, other Japanese data continued to show improvements as wage growth increased for the first time in nine months, signaling that corporate profits may be finally filtering down to the wallets of the Japanese labor force and raising hopes of better consumption trends in the months ahead.

The primary event risk for the Japanese Yen this week comes on the evening of October 10, when the Bank of Japan announces their target rate just before midnight (ET time). The central bank is widely expected to leave rates steady as economic expansion remains feeble and consumer prices remain in deflation. Nevertheless, the BOJ is considered to maintain a hawkish bias amidst inflation in assets such as land and concerns that rate normalization needs to be enacted sooner rather than later. As a result, a bit of volatility could ensue just before and after the rata announcement, but the net result will likely see the Japanese yen weaken. Furthermore, USD/JPY is likely to break 117.12 and test at least 118.00, as a push to this level would complete an A-B-C corrective rally from 111.59.

UK Data Weighs Pound, Mum BoE Defers Any Future Rate Cuts
The pound’s economic dance card was full this past week, with event-risk spread evenly across the playing field. Of all the scheduled events, though, no single affair held the masses attention like the Monetary Policy Committee’s rate decision on Thursday. Market participants and analysts alike were heavily expecting the policy group to leave lending rates untouched at 5.75 percent. While no one was holding their breath for a hike or a cut, there was considerable uncertainty over whether Governor Mervyn King would issue another statement on the market and economy’s health, potentially a means for policy makers to desensitize traders to a possible impending rate cut. Typically there is no brief released when no changes are made to monetary policy; however that wasn’t the case last month. Instead of the standard memo citing no change, the market received a rather lengthy note that centered on the uncertainty surrounding the disturbance in the credit and money markets. It is interesting to note that they mentioned the pull back in inflation to a 1.9 percent annual rate, its slowest pace in 17 months and below their 2.0 percent target. While they are unlikely to change rates before the financial markets’ problems blow over, their mention of soft price pressures could mean that when things are back to normal, the BoE will emerge with a dovish hue.

On the data front, the indicators were furthering the bears’ case. The Purchasing Managers Index series offered up consistent disappointments. The manufacturing gauge backed off a two-year high while the services report stepped down to match its lowest level in at least a year and half. The rest of the top tier reports hammered on the increasingly gloomy housing market. The construction PMI report backed off a nine-year high last month. More discouraging was the weaker than expected housing equity withdrawal number for the second quarter. And, to top it off, the HBOS housing price indicator joined the other inflation numbers by reporting its first decline in nine months.

Scanning the docket for the coming week, the fundamental risk is decidedly front ended. Monday will test the waters on inflation and factory activity for the month of September and August respectively. Input prices for producers are expected to have surged last month, perhaps encouraging pricing managers to pass on some of the burden to the consumer. Industrial production during the beginning of the credit upset is tentatively expected to improve. Moving ahead to Tuesday, the physical trade balance will gauge demand versus the pound’s highs. Finally, the RICS House Price Balance survey will round out the major housing reports for September.

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 18 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 1, 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 USD/CHF 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 USD/CHF.

Canadian Dollar Soars as Unemployment Hits New Low
When liquidity flooded the market last week, the Canadian dollar was back on the advance. On Monday, the USD/CAD crawled to mark a new 32-year low - barely nudging out the record put in on the previous Friday – just above 0.9900. However, with crude pulling back from its own highs and no data on deck until Thursday, a modest retracement was in orders. The USD/CAD’s buoyancy found a modest fundamental wind when the first few indicators crossed the wires. First up was the building permits report for August. The approvals report is typically a very volatile report, so the 1.4 percent increase in permits for the month, hardly warranted a ‘big’ reaction. A little more discouraging for the loonie’s steady run was the Ivey PMI number. Business spending unexpectedly slipped in September, as the money market rout overwhelmed favorable export and exchange rate trends.

When all was said and done though, the labor market survey took top prize for event risk. Heading into the Friday event, both sides of the USD/CAD pair were expecting jobs numbers to cross the wires. The tension in the market was thick. In all likelihood, many market participants were probably ready to write off the Canadian data as it would just be a diversion from the US NFPs due only an hour and a half later. Certainly, the US payrolls had the better back story and setup. The August employment report was first to report a net loss in jobs in four years. Traders in the world over and in every asset class were waiting to see whether the American consumer was going to loose the spring in his step with confirmation of a weaker job market. Further making the US release a special event, the usual six month revision was expected to produce some dramatic results. However, the Canadian report would ultimately end up a more market moving report than its US equivalent, thanks to its consistency. A 51,100 net increase in Canadian payrolls was the biggest jump in five months and nearly triple the market’s forecast. Looking at the other statistics in the Labour Force Survey, full-time jobs in the service sector enjoyed the majority of increase, the unemployment rate unexpectedly dropped to a 33-year low 5.9 percent, and wages rose the most in at least a decade.

After the Canadian employment numbers hit the wires, USD/CAD quickly dove below 0.9900 on a sharp, 95-point decline. Now, more than ever, with the Canadian dollar pushing to fresh 31-year highs against the greenback, consistent fundamentals and steadily rising commodity prices are essential. Looking at the days ahead, a few top tier indicators will cross the ticker. Tuesday’s housing starts report for September and the August new home inflation index will reveal whether the US’s problems are contagious. Also scheduled for release is the physical trade report for August, a key number for loonie bulls to watch considering the assistance the currency has garnered from exports.

Australian Employment Report Holds Key to Aussie Performance
The Australian dollar set fresh 18-year highs through the past week of trade, with continued US dollar weakness and renewed carry trade demand boosting the high-yielding currency. The aussie spent much of the week trading lower as the greenback showed faint signs of life in the early going, but a Friday USD tumble left the A$ firmly higher through the close. The week’s economic data proved broadly mixed, and the highly-anticipated Reserve Bank of Australia interest rate announcement failed to deliver a hike in the official Cash Target Rate. The mild disappointment was offset by a simultaneous Retail Sales report, which showed that spending grew by a robust 0.7 percent through the month of August. Given strong consumer spending and labor growth, markets continue to expect that the Reserve Bank will have little choice to raise rates through year end. Such forecasts have undoubtedly fueled Australian dollar gains, but it will be important to watch the coming week’s Employment Change data to gauge the likelihood of such interest rate increases.

Upcoming event risk will be dominated by the aforementioned Employment Change report due Thursday, while earlier second-tier data likewise shows potential to force short-term volatility. Notables include the NAB Business Confidence result and Westpac Consumer Confidence figures, while Home Loans will draw close attention, given a background of financial and lending market duress. Forecasts show expectations for strong results across the board. We pay special attention to consensus estimates of a 20.0k Employment Change through the month of September. To put this into grossly oversimplified perspective, a gain in 20,000 jobs would represent the equivalent of a +284,000 jobs result for the US Nonfarm Payrolls report. It is this type of economic strength that has bolstered the Australian economy in the face of slowing global economic growth trends, and a positive result in Thursday’s Employment Change data would undoubtedly boost the domestic currency further above recent 18-year heights.
 
New Zealand Dollar Bulls Hope for Strong Retail Sales
The New Zealand dollar underperformed its Australian counterpart despite a strong rebound in carry trade interest, as reports of sizeable bond redemptions led international investors to repatriate NZ$ holdings. Kiwi traders were nonetheless able to leave the NZD/JPY higher through the end-of-week close, finishing above key technical resistance and hinting at potential for further gains. Such carry trade-linked demand was undoubtedly related to a large-scale improvement in global risk appetite, with record highs in US stock prices and similar heights in other international bourses keeping high-yielders bid. Whether or not this will continue is tough to predict, but traders seem willing to keep risky assets bid through upcoming trade.

An upcoming Retail Sales report dominates event risk for the Asia-Pacific currency, while relatively second-tier ANZ Business PMI data has an outside chance of forcing short-term volatility in NZD pairs. Analysts expect that Retail Sales rebounded through the month of August, showing reasonable spending growth from the domestic consumer. Of course, New Zealand dollar bulls hope that unemployment levels at multi-decade lows will stoke spending at a much quicker pace; the Reserve Bank of New Zealand previously cited strong consumption levels as justification for raising interest rates to record heights. Given forex traders’ renewed emphasis on interest rate differentials, rising Kiwi yields could instantly boost the currency’s stance against major foreign counterparts. Otherwise, the NZD will be left to continue trading off of global risk appetite and equity market performance. Given strong stock market rallies, risks for the Kiwi remain to the upside through short-term price action.

Boris Schlossberg is a Senior Currency Strategist at FXCM.