Dollar: Struggling to Find Bottom
The week ended nearly where it began as the greenback settled only 50 points from last Friday’s close. In between however, the pair saw a fair amount of action as the EUR/USD dropped to within a few points of the critical 1.4000 level before rebounding hard. As we noted at the time, “The unit continues to attract late buyers who missed the initial rally to 1.4200 and now perceive the 1.4000 figure as a bargain.“

As the week progressed the greenback was weakened a bit after the release of the FOMC notes revealed Fed members expressed little concern over inflation, remaining essentially neutral in their assessment of pricing pressures and more focused on risks to growth. While the latest communiqué from the Fed showed little inclination to cut rates yet again in October, the general tone of the discussion suggested a willingness to loosen monetary policy further before the year end. By Friday all talk of easing in October was off the table as Retail Sales beat expectations rising 0.4% vs. 0.3% forecast. The data showed that the US consumer may have stumbled but had not fallen as relatively strong labor markets and wage growth continue to support consumption and offer little reason to lower rates this month.

Next week the focus will be on housing and TICS data. After last month’s surprisingly low inflows of only 19.2 billion the market anticipates a snapback to 63 billion surplus. The TICS data can be notoriously volatile - that why last month’ weak showing was essentially ignored - but if the TIC inflows are anemic for a second month in a row, the greenback could see further weakness as worries will escalate about US’s ability to finance its current account deficits. Housing too could weigh on the dollar as permits and starts are expected to decline yet again, but unless the data is particularly woeful, most of the negative news has already been backed into the price. In summary it may be another week of consolidation, but barring further bad US data, the greenback decline appears to have stabilized and the unit may be close to a near term bottom.

Euro – All Eyes on Inflation
Euro data proved relatively positive last week, most notably in the industrial sector where Industrial Production rose 1.2% versus only 0.2% expected. The news assuaged fears that higher euro was hurting the region’s exporters, but the currency saw little lift from the news. As we wrote on Friday, “One reason for the apathy of the market may have to do with the fact that German IP results were already known and therefore the upside surprise in the broader EZ number was not really news. Furthermore, the results, while impressive, are for two months back and may not accurately reflect the present day conditions for European exporters as EUR/USD continues to float above 1.40 making their products considerably less competitive on the world stage. “

Next week all eyes will be on the EZ CPI which is expected to remain above the ECB self-imposed threshold of 2.0%. Over the past week a series of ECB officials have issued hawkish declarations, minimizing the impact of the high EUR/USD exchange rate and emphasizing the need to control pricing pressures. We noted that after having fully priced in the September 18 50bp cut from the Fed, the currency markets now need additional rate reductions to drive the greenback lower. The flip side of that equation is that the EUR/USD could maintain its rally if ECB backs up its hawkish posture with policy and takes rates higher. If the CPI numbers do indeed print hotter, the market could begin to price in another hike before year end.

USD/JPY Could Push Above 118.00 as Carry Trades Remain Intact
The Bank of Japan’s announcement that they would leave rates steady at 0.50 percent allowed USD/JPY to continue to climb up towards the 118.00 level this week, as risk-seeking traders keep carry trades in play. Indeed, with Japanese economic expansion remaining feeble and consumer prices still in deflation, there was little support for a rate hike this time around. Nevertheless, the BOJ is considered to maintain a hawkish bias, with the help of the sole voter for a rate increase, Atsushi Mizuno, amidst inflation in assets such as land. Furthermore, in BOJ Governor Toshihiko Fukui’s post-meeting commentary, the bank sounded a bit more confident about current conditions yet still cautious as he said, "International financial markets showed some improvement, as evident by rises on the stock market to the pre-crisis level, but they continue to be unstable as a whole...We find it necessary to closely watch the global economy and financial markets." As a result, traders are not likely to see the BOJ raise rates until is becomes clear that a credit crisis has been averted.

This week, economic data out of Japan is unlikely to make a large impact on USD/JPY price action as the risk-seeking nature of the markets could easily remain the primary driver of price action across the yen pairs. Nevertheless, traders should watch for upcoming news that could affect the BOJ’s policy stance in coming months. The final industrial production reading and the tertiary industry index are likely to show that conditions in the manufacturing and services sector are improving. However, until price growth turns positive once again, the BOJ will have trouble validating their logic for continuing on with rate normalization this year. Thus, if carry trades, including the equity markets, continue to rack up gains, USD/JPY could push above 118.00 this week.

UK Housing a Lingering Issue as 3Q GDP Comes Online
The UK economic calendar was certainly mixed this past week, and it reflected in price action. GBP/USD was cutting a broad range between 2.0250 and 2.0450, waiting for a key fundamental push to help the pair find a genuine direction. Scanning over the specific indicators offering the sterling fundamental guidance, nearly every dour report had its silver lining. First up was the upstream PPI inflation numbers for September. For rate watchers the acceleration in the year-over-year 2.7 percent output figure was a disappointment as it came below the market’s 2.9 percent forecast. On the other hand, the official print matches the highest level of wholesale inflation recorded in 14 months. What’s more, a 6.4 percent increase in input prices suggests business may pass its rising costs onto consumer later down the line. On that same day, the industrial production report for August fell short of its 0.3 percent consensus with a modest 0.1 percent. However, the manufacturing sector actually recorded its strongest pace of growth in six years. Another mixed report was the visible trade balance for August which trimmed its deficit from the previous month, yet the improvement made over the worst deficit in records going back over 300 years.

And, standing aside from the other indicators that hit the wires last week, the RICS House Price Balance survey for September gave the market its weekly update on the health of the housing market. Adding to concerns first raised by the Rightmove’s first decline in a year and the HBOS report’s first negative number this year, the RICS gauge revealed a net 14 percent of its surveyors reported falling housing prices, the worst reading in two years. If any or all of these indicators begin to show a negative trend, concern over the health of the housing market may start to weigh on the pound in earnest. Fears will be fed (or relief found) early this week with the October Rightmove due Sunday evening and the DCLG residential inflation gauge for August scheduled for release early Monday.

The housing data aside, the days ahead are jam packed with top notch market-movers. The CPI and RPI data for September is set with forecasts of a modest acceleration in price pressures. The employment and earnings figures for Wednesday are sporting equally benign projections. Last month’s retail sales report could grease the wheels for the next GPB/USD leg, but the brunt fundamental force will be provided from the third quarter GDP report. The advanced reading from the quarterly report is expected to cool slightly from the previous period with a 0.7 percent pick up in growth. The annual figure, on the other hand, is expected to hold steady at a 3.1 percent rate of expansion, opening the door to either upside or downside surprises.

Swiss Franc Looks to Decline on Poor Speculative Sentiment
The Swiss franc declined sharply against major forex counterparts, as a revival in carry trade interest sunk the low-yielder through the week of trade. Such weakness allowed the downtrodden US dollar to reclaim lost territory against the Swissie, and recent speculative positioning surveys support further USD/CHF rallies. Last week we cited overextended CHF-longs as a primary risk to the Swiss franc’s performance. According to the CFTC Commitment of Traders report, net Swiss franc positioning showed a slight deterioration in the week ending October 9. A continued worsening will turn speculative and commercial interest further bearish the currency and is likely to bring further declines. Whether or not the US dollar will continue to outperform the currency is perhaps another matter, but it seems that risks remain firmly to the downside for the Swissie through the medium term.

Upcoming economic event risk will likely clarify expectations for the future of Swiss economic growth, but typically non-market-moving events are unlikely to force worthwhile volatility across CHF pairs. First on the ledger is the Retail Sales result for the month of August, which is forecast to show a notable 4.1 percent year-over-year gain. The survey tends to be quite volatile and unpredictable on a month-to-month basis, however, and we could easily see such results come in on any side of consensus forecasts. Other fairly significant event risk will include Thursday’s Trade Balance and Swiss ZEW results. The former is likely to show that the trade surplus was strongly improved through the month of September, as a weak currency and strong Euro Zone consumption boost demand for domestic production. Yet an overall negative trend in ZEW business confidence results suggests that domestic producers maintain a fairly pessimistic outlook on overall consumption gains. Though the headline print is likely to improve following a stabilization in financial market conditions, it seems probable that the business sentiment survey will reflect tempered forecasts for the future of profitability growth.

Canadian Dollar Rockets as Oil Hits Record Highs
The Canadian dollar ended last week at yet another multi-decade high against the US dollar as crude oil closed at a record high of $83.69/bbl on the New York Mercantile Exchange. Economic data out of Canada helped the national currency as well, as the merchandise trade surplus widened to $C4.1 billion in August as a result of a decline in exports and an even sharper decrease in imports, which had hit a record high the month before. Meanwhile, the housing market outperformed as a hot condo market sent housing starts to a 29-year high of 278,200 units from a revised 232,700 units in August. With tight labor markets helping to fuel demand for new properties and creating substantial inflation risks, the Bank of Canada will have little room to follow the US Federal Reserve’s lead and cut interest rates this week.

Nevertheless, the BOC will have some major issues to mull over when they meet this Tuesday. First, the Canadian commercial paper markets were some of the hardest hit by the August credit crunch, which was likely one of the primary reasons why the bank left its key lending rate at 4.50 percent on September 5 and removed a suggestion that they may lift rates from their accompanying statement. Furthermore, the rapid appreciation of the Canadian dollar against the greenback will surely be a concern, but the question is: will they cite it in their policy statement? This is unlikely, as such a notation would spark speculation that the BOC will move to intervene in the FX markets. Nevertheless, the US is by far Canada’s biggest trade partner and purchases more than 75 percent of their exports. With the price of Canadian goods rising dramatically for US purchases, producers could feel the pinch of softer demand. Regardless, with inflation risks on the upside and the financial markets currently stabilized, the BOC is expected to leave rates unchanged. This creates the potential for additional gains for the Canadian dollar, especially as CPI is anticipated to jump back above the 2.0 percent target. Moreover, FXCM SSI shows that 85 percent of traders are long USD/CAD, and as a contrarian indicator, the data signals that this week may not be the time to try to go against the clear trend: down.

Reserve Bank of Australia to Signal Further Interest Rate Hikes
The Australian dollar scaled new 23-year heights against its US namesake, as a sharp carry trade rebound fueled demand for the high-yielding currency. Global stock market rallies and improved risk appetite kept the aussie bid, while largely positive economic data likewise improve prospects for the Asia-Pacific currency. An addition of 13,000 jobs in September pushed the national unemployment rate to 33-year lows of 4.2 percent, while the labor force participation rate remained near all-time highs at 65.0 percent. The result proved undoubtedly bullish for the future of consumption trends, and financial market speculators subsequently increased expectations that Australian interest rates would rise through the medium term. Given that currencies tend to move strongly on shifts in yield forecasts, claims that the Reserve Bank of Australia will have to hike rates in 2007 will likely fuel further AUD/USD rallies.

The upcoming Reserve Bank of Australia Monthly Bulletin will shed further light on the interest rate debate, and markets are likely to react to any notable shifts in the bank’s rhetoric on economic growth and inflation. In its August statement, the central bank highlighted the fact that economic growth prospects remained strong for the Australian economy, with special mention of “higher-than-expected” inflation raising the prospects of monetary policy tightening in the months ahead. Yet a rather prominent focus on financial market difficulties gave sign that officials were concerned over the effects of credit market turmoil on overall growth. Given that money market conditions show subsequent signs of improvement, we will likely see the bank take a more optimistic stance on global expansion. It seems that risks for the Australian dollar remain positive ahead of the report, and we see relatively little reason that markets will force notable retracement in Aussie gains.

The typically quiet New Zealand fundamental calendar was bustling this past week. The major indicators for the period could be tidily grouped into three categories: consumer spending; business activity; and housing activity – the RBNZ’s primary policy points when considering interest rates. Without a doubt, Alan Bollard’s principal concern is Kiwi natives’ rampant spending habits (especially on credit). The lagging August retail sales report have offered some sign that the string of rate hikes from the central bank through July are starting to take effect. The 0.2 percent rise in sales was only half what economists were predicting. Alternatively, when the 2.9 percent and 0.7 percent drop in gas and auto sales respectively were removed from the indicator, the 0.8 percent jump in consumption actually marked a six-month high.

Official commentary and public addresses by Governor Bollard also frequently touch upon the central bank’s concern over the momentum in the housing market and how it is funding exuberant spending habits. The data from Quotable Value New Zealand, a government valuation agency, offered a slight reduction in year-over-year price growth through September from a 17-month high 13.3 percent pace to 13.2 percent. The Real Estate Institute of New Zealand’s housing sales report on the other hand, showed a different side of the housing market over the same period. While its own average price component was still rising at a steady clip, the headline annual sales activity figure actually dropped 31.9 percent for the biggest decline in 9 years. If these sales numbers are to be believed, it is likely only a matter of time before inflation in the sector follows suit. While the consumer and residential sector, the highflyers of the economy, are starting to loose altitude, the struggling manufacturing sector may actually be coming out of New Zealand’s economic storm (record interest rates and a 25-year high currency). The NZIER Business Opinion Survey for the third quarter, marked a considerable improvement in sentiment for the activity in the final three months of the year. A net 15 percent of respondents project a pickup in domestic trading while component gauges for employment, ease of passing on costs and profitability have all improved.

Now that the major growth sectors have been covered, kiwi traders will absorb data on the RBNZ’s only true charge: consumer inflation. The third quarter CPI report is expected to print a 0.8 percent increase in the basket over the three months with a neutral 2.1 percent annual figure. Of course, these are notably close to the previous quarter’s figures; so event-risk may be in play. Any sign that inflation is still a problem, could put policy rhetoric right back on the warpath. Otherwise, it will only be a matter of time before cuts are discussed.

Boris Schlossberg is a Senior Currency Strategist at FXCM.