Dollar: How Low Can It Go?
This week, the markets saw further evidence of US slowdown as Existing Homes plunged -8.0% lower, jobless claims recorded their second consecutive print of 330K+ claims and Durable Goods contracted -1.7% against expectations of a 1.5% rise. Even the seemingly positive New Homes number was deceptive as prior month's reading was revised downward demonstrating that the housing sector is in a full-out recession.

Little wonder then, that as data hit the screens, rumors started to circulate that the Fed will cut rates by 50bp rather than the expected 25bp at next Wednesday’s FOMC meeting. Should that occur the EUR/USD can easily hit 1.4500 as the interest rate differential in the pair will compress to a mere 25bp lead for the greenback. Already EZ 2-year swap rates are higher than those of the US indicating that fixed income markets are betting that US rates will fall below those of the Euro-Zone. On the flip side, with anti-dollar sentiment so prevalent in the market, a 25bp cut may spur a relief rally for the greenback, especially if the NFP numbers due two days later print at 100K+ or above. The Fed appears to have made a calculated decision to offset the loss in housing wealth with strong growth in exports. If that policy results in steady labor markets, their gamble may just pay off and the greenback should stabilize. For now, however, these are the darkest of times for dollar bulls.

Euro – Signs of a Slowdown
Euro’s climb towards 1.4500 continued this week, but on the economic front the data started to show signs of a slowdown. On Friday, the German GFK Consumer Confidence poll missed badly to the downside printing at 4.9 versus 6.5 expected. The reading for November hit a seven-month low as sentiment soured after the financial market turmoil of August made consumers more cautious. More troubling still, the propensity to buy index was strongly negative in October at -12.9 versus -2.4 in September suggesting that Retail Sales may come in weaker than expected. Meanwhile, Industrial Production rose only 0.3% vs. 0.9% expected and the flash PMI Manufacturing reading came dangerously close to the 50 boom/bust line at 51.3.

The overall picture suggests that the ECB is quite unlikely to tighten further, for fear of stifling the region’s delicate economic recovery. The one area of concern for European monetary officials is the continued double digit growth in money supply figures. However, even the 11.4% pace of growth in M3 has failed to translate into any meaningful price pressures as EZ core CPI data remains at 1.5%.

Next week, the European calendar is especially light with only the unemployment and PMI manufacturing data on the docket. The trade will almost certainly be driven by the North American data and risk appetite/risk aversion dynamics. The EZ economic situation, as long as it remains steady, is almost an afterthought to the market right now. The euro continues to trade as the anti-dollar.

Yen Rallies After G7 Remains Mum on the Japanese Currency
In the wake of the G7 meeting of Finance Ministers in Washington, the Japanese yen rallied sharply against the U.S. dollar. Finance Ministers from the world's biggest economies showed a lack of concern on the continued fall of the U.S. dollar and preferred to call for faster appreciation of the Chinese yuan. On Sunday ET, the US dollar fell to as low as 113.27 yen after having traded at 114.50 on Friday, October 19. However, during the rest of the week the price action was rather choppy and the USD/JPY traded off mostly in the developments in the equity markets.

This weak data reinforced expectations the Bank of Japan will keep interest rates on hold over the next few months. For instance, according to a government report released on Friday, Japan's nationwide core consumer price index fell 0.1 percent in September from a year earlier. This was the eighth straight month of core CPI deflation. Even so, Tokyo’s CPI, a leading indicator of national price trends rose by 0.1 percent, the first increase we have seen in five months, and an indication that higher crude oil prices could soon be spreading across the broad economy. Other reports released on Friday showed that production in the industrial sector of the Japanese economy fell 1.4 percent in September from the previous month, compared with expectations for a 1.3 percent drop. Earlier in the week, a report showed that Japan's September adjusted trade surplus hit a record high of ¥1.03 trillion, largely supported by a decline in imports.

Looking at the week ahead, we will keep our eyes on the Bank of Japan interest rate decision and our attention on Mr. Toshihiko Fukui's speech, the Bank of Japan Governor, when the BoJ Policy Board meets next Wednesday. The BoJ is widely expected to keep interest rates on hold. In fact, Interest rate swaps on the overnight call rate are pricing in less than a 20 percent chance the BoJ will increase rates before the end of this year. In addition, markets will watch for any particularly large surprises out of Retail Sales, Overall Household Spending, Unemployment and Manufacturing PMI, all expected to be released between Monday and Tuesday.

Cable Consolidates Near 2.05 Amidst BOE Rate Cut Prospects
On Thursday, the Bank of England issued a gloomy outlook for the UK’s financial markets, noting that the credit, equity, and commercial property markets remain “vulnerable to further adjustments.” The BOE pointed the finger at a sharp slowdown in the US economy and rising credit defaults that “could trigger a further round of asset price falls.” While this analysis does not necessarily suggest that the central bank will be aiming to cut rates in the near-term, it does effectively eliminate much of the probabilities of a rate hike. Indeed, BOE Governor Mervyn King is a staunch hawk and extremely hesitant to enact policies that create the potential for moral hazard to come into play – though one could argue that the BOE’s bailout and guarantee of funds at Northern Rock just a few weeks ago was the epitome of just this. Nevertheless, until UK data starts to reflect a more pronounced economic slowdown and easing in price pressures, interest rates in the UK will likely hold at 5.75 percent until at least Q1 2008.

Looking ahead to the British pound's event risk this week, Cable bulls may be disappointed to see that most of the data is expected to signal a slowdown in the UK economy. Nationwide house prices are anticipated to have slowed to an annual growth rate of 8.5 percent from 9.0 percent, as the BOE's policy tightening earlier in the year takes a toll on the housing sector. In fact, we've already seen that mortgage application figures have started to fall back, and the softer demand could finally forces sellers to knock down prices a bit. Meanwhile, GfK consumer confidence may drop further to –8, as sentiment will undoubtedly remain negative amidst high oil prices and concerns about the health of the financial markets. On Thursday, PMI manufacturing could give some clues as to how exports are faring with the British pound holding consistently above the $2 mark. Overall, much of this week's news is likely to suggest that after the UK expanded rapidly in Q3, growth during Q4 will probably fall off markedly and underpins the bearish case for the GBP/USD pair.

Swiss Franc Holds the Bid
The Swissie continued to follow anti dollar sentiment ending the week pretty much where it closed last Friday. At the start of the week SDCHF staged a huge fake-out, rallying 280 points only to give nearly all of it back by the end of the week. The franc continued to weaken against the euro as modest carry trade flows kept the pair bid, but overall it basically matched its much larger neighbor in making gains against the greenback.

One possible reason for Swissie bullishness was the continuing hawkish commentary from the SNB. The Vice Governor of the Swiss National Bank, Mr. Philipp Hildebrand, in a speech in Switzerland Thursday said that the Swiss economy was "robust," and noted that “should our inflation forecast show that the development of the foreign exchange rate threatens price stability in the medium term, this would be a reason for the Board to reassess the degree of restrictiveness of monetary policy.”

The SNB’s decidedly hawkish stands suggest that they may deviate from the ECB and raise rates at the December meeting, but that decision will be almost exclusively contingent on the inflation figures, which is why Friday’s CPI report could carry so much weight with the market. If the CPI prints hotter than expected then the FX markets could reassess their EuroSwiss rate expectations; and the EUR/CHF pair, which up to now has traded almost exclusively on carry trade flows, could begin to weaken as traders shift capital to the franc.

Canadian Dollar Shows Few Signs of Slowing at 33-Year Highs
The Canadian dollar showed little hesitation in pressing onto fresh 33-year highs against its US namesake, with all-time highs in crude oil prices and general US dollar weakness sinking the USD/CAD to new depths. The currency pair’s early-week rally gave false hopes for a notable medium term reversal, but speculators pounced on the opportunity to continue selling the USD/CAD. Loonie buying pressures likewise coincided with bullish Canadian Retail Sales results; despite a disappointing Wholesale sales report, retailers saw sales grow 0.7 percent through the month of August. Robust employment gains have driven consumption trends in the world’s eighth largest economy, and CAD bulls hope that the coming week’s Net Change in Employment report will show continuation of labor market gains. The coming week clearly promises volatile conditions for all US dollar-denominated currency pairs, and the USD/CAD is certainly no exception.

We are likely to see major moves in the Canadian currency in the days ahead, as a mid-week US Federal Reserve interest rate announcement and Friday labor data are both virtually guaranteed to force volatile moves in the C$. A Wednesday Gross Domestic Product report is likewise slated to grab forex market headlines, but it is relatively unlikely that we will see notable price movements ahead of the critical US FOMC announcement. That being said, USD/CAD risks remain to the downside ahead of Wednesday’s events. Speculation that the US Federal Reserve may cut rates by as much as 50 basis points has kept the US dollar on offer through recent trade, and such a move could only drive the greenback to fresh depths against its Canadian dollar. Friday’s employment numbers likewise show potential for driving further USD/CAD drops; the Net Change in Employment figures has beaten consensus forecasts for 7 out of 10 months this year. Given a median analyst estimate of a relatively minor 11,000 job gain, we could easily see the result come in stronger than expected. Given such bullish economic prospects, we see relatively little scope for fading Canadian dollar strength through short term trade.

AUD/USD Swept to 23-Year High on Surprise Jump in Inflation, Gold
A volatile mix of fundamentals and commodity price action pushed AUD/USD above 0.91 last week, marking the highest level for the pair since June of 1984. The few indicators sprinkling the calendar were evenly spaced. And, while the fundamental reports were few in number, they were considerable market-movers in their own right. Beginning with the least influential report, the Conference Board’s composite Leading Index of economic indicators jumped 0.6 percent for its August measurement, the largest jump in six months, through gains in the money supply, building permits and equities. Conversely, the impact this indicator had on the Australian currency paled in comparison to the fuel provided by the third quarter factory and consumer-level inflation reports. The PPI report set the Consumer index up for a relatively uneventful release.

According to the Bureau of Statistics, prices at the factory gate unexpectedly accelerated 1.1 percent in the three months through September, lifting the more closely watched annual report off of its three-year lows to a 2.4 percent clip. However, the modest rebound in factory-level price pressures didn’t accurately reflect the strain at the consumer level. The CPI data was antipodal, with headline annual figure cooling to its slowest gait in 8 years at 1.9 percent while its headline counterpart accelerated to a 16-year high 3.1 percent.

During the lull in scheduled, fundamental currents last week, commodities easily took over the helm on the Aussie dollar. Energy, agricultural and metal prices rallied across the board, paced by crude and gold. While Australia is the among the top producers of multiple natural resources (coal, zinc, beef), no correlation held as tight as the one with gold. The precious metal rallied to a 28-year high above $780/ounce just as AUD/USD pushed to its own recent record. Even if all the event risk on the docket this week should fall flat, gold and the many other commodities in the Australian export universe could easily drive the currency to gains or losses on their own.

While there is a backup in place with commodities, the economic calendar doesn’t look like it will disappoint. The data begins early with the NAB business confidence numbers for the third quarter. The survey crossed the wires with a four-year high in its last reading; but turmoil in the financial market, higher raw material costs and rate hikes have significantly depressed the monthly figures. On the following day, a double shot of housing data will gauge lending habits through HIA new home sales and building permits. The trade deficit announced Thursday morning is expected to improve substantially, but its simultaneous release with the monthly and quarterly retail sales data should dampen its potential. The consumer spending numbers are set to weaken slightly for September, but accelerate to a 1.6 percent clip through the third quarter. With inflation already checked off, consumer spending is the next hurdle for another rate hike.

RBNZ Leaves Door Open for Further NZD/USD Gains
The New Zealand dollar continued to rally against its US namesake, as rallies in global stock markets and a surprisingly hawkish central bank sent the currency to multi-week highs through Friday’s close. Previous tumbles in global risky asset classes left the Asia-Pacific currency offered through mid-October, but a recent reversal left high-yielders cautiously bid ahead of next week’s critical US FOMC interest rate announcement. The US central bank is widely expected to cut domestic short term rate targets by at least 25 basis points, with hopes of a 50bp cut fueling stock market rallies through earlier-week price action. The New Zealand central bank shows little indication that it will pursue similar moves through the medium term, however, as a surprisingly hawkish stance on inflation forced speculators to scale back forecasts for RBNZ rate cuts. Tepid third quarter Consumer Price Index figures had originally led many to believe that the bank would ease rates from record-heights, but RBNZ Governor Alan Bollard emphasized that price pressures remain a top concern for the central bank. Given expectations for a widening of the New Zealand dollar – US dollar yield spread, the NZD/USD may continue to rally through medium term trade.

Upcoming economic event risk is relatively limited for the New Zealand economy, with an early Trade Balance report and Monday’s Building Permits data the main highlights on the Kiwi ledger. The first is likely to show that the trade deficit narrowed from the 10-month trough seen in August, while Building Permits are forecast to worsen after a surprising gain in August. Of course, traders may temper their reactions to either report ahead of Wednesday’s critical US FOMC interest rate announcement. The decision is very likely to have strong ramifications for global equity markets, and US stock market bulls have been buying stocks in hopes that the Fed will cut interest rates aggressively through year end. Any disappointments on this front could easily sink corporate shares, however, and investors would likely sell risk-sensitive carry trade pairs through the same period. If the Fed does indeed cut interest rates by 50 basis points, however, we could easily see the NZD/USD extend gains onto multi-month heights in the days that follow.

Boris Schlossberg is a Senior Currency Strategist at FXCM.