US Dollar: Are All Bets Off for an October Rate Cut?
We are continuing to see directionless movement in the US dollar which has strengthened against some currencies but fallen against others. Futures traders got it right yesterday when they drove rate cut expectations down sharply following the release of the FOMC minutes. Equity traders have finally followed suit by taking the Dow down 80 points today. It seems to be only a matter of time before currency traders take the dollar higher as well. The only reason why they are holding back is because they want to see Friday’s retail sales and non-farm payrolls report before deciding whether all bets are truly off for an October interest rate cut. Tomorrow’s report on import and export prices will be a leading indicator for whether producer prices last month were as firm as the market expects. In addition to PPI, the trade balance and jobless claims are also due for release. Inflationary pressures are expected to rise as the result of strong commodity prices and a weaker dollar. The latest comments from FOMC voter Rosengren indicate that the Fed supports a weaker dollar. Rosengren said that a weaker dollar is good for exports and for the time being, the pass through inflation from foreigners are not nearly as great as we might expect because a number of foreign importers frequently price to the US market rather than their own market. We continue to believe that the Federal Reserve does not need to lower interest rates at the end this month, especially if retail sales remain positive. The have already made a big move to stabilize the economy and so far, it seems to have worked. All we need now is to make sure consumer spending holds steady and data indicates that inflationary pressures are as strong as the Fed suggests. If that materializes, then the Fed has all the flexibility they need to leave interest rates unchanged, and dollar bulls have the fundamental reasons to take the currency higher.

Don’t Bet Against the ECB
We have learned in the past to never bet against the European Central Bank. As a monetary policy authority that cherishes stability and despises volatility, the ECB never likes to catch the market by surprise. Therefore, as much as people may want the ECB to intervene to weaken the Euro or to lower interest rates, they should respect the fact that the ECB not only refuses to do so, but instead chooses to remind the markets that they are still very hawkish. They have no interest in saying one thing and doing another. This morning ECB member Garganas said that ECB policy remains “rather accommodative” because they feel that inflation will stay above 2 percent for the remainder of the year. They continue to warn that developments are monitored closely and they stand ready to act in a timely manner if needed. This morning’s economic data was also Euro positive with French and Italian industrial production both rising more than expected. Tomorrow we have the German wholesale price index as well as the ECB monthly bulletin for October which includes the EC’s GDP forecast for the next three quarters. The monthly bulletin will shed more light on the ECB’s current economic assessment.

British Pound Strengthens on BoE Comments
Comments from Bank of England Governor King helped to inject some new life into the British pound today. According to the central bank head, "Even though inflation is close to the target and pay pressures are muted, we will continue to look ahead and monitor the risks to inflation that we identified in August." More specifically, King said that business and financial surveys indicate expectations for increased inflationary pressures in the months to come, suggesting that hikes in price could be passed onto consumers. For British pound traders, the chance of a rate cut from the Bank of England has fallen on the back of the central bank’s comments. There will be no more data to clarify the interest rate outlook for the remainder of the week which leaves the GBP/USD’s movements vulnerable to US data.

Japanese Yen Weakens Ahead of Bank of Japan Rate Decision
Japanese yen crosses are rallying ahead of this evening’s Bank of Japan interest rate decision. The central bank is widely expected to leave interest rates unchanged because deflation remains a constant battle. Earlier this week we had talked about how the cell phone price war in Japan is driving prices lower. Today, convenience stores were split on whether to raise food prices on some products despite an increase in their own costs. Although the problems in the credit markets have subsided, the fact that the Federal Reserve has initiated the trend of lowering interest rates makes a rate hike by the Bank of Japan stick out like a sore thumb, and Japanese growth has not been stellar enough to warrant a rate hike. Even though the Dow is weaker today, the yen still sold off against every major currency pair with exception of the Australian, New Zealand and Canadian dollars.

Australian, New Zealand and Canadian Dollars: Weaker Across the Board
The Australian, New Zealand and Canadian dollars are weaker across the board despite slightly higher gold prices. The recent rallies in commodity currencies have become very overextended which makes today’s correction hardly a surprise. There was no economic data released from Canada, but Australia reported a drop in consumer confidence for the month of October, and improvement in investment lending and home loans in the month of August. The housing market in New Zealand, on the other hand, is not faring as well, with sales of houses in New Zealand falling by the most in more than 9 years. New Zealand business PMI is due for release tonight along with Canadian international merchandise trade balance and new house prices tomorrow. For the time being, the uptrend in all three pairs is intact.

Kathy Lien is the Chief Currency Strategist at FXCM.