Busy Trading Week Ahead: What’s Next for the US Dollar
It has been an extremely active week in the financial markets with the Dow falling over 500 points, the US dollar hitting a fresh record low against the Euro and carry trades breaking down. Traders who thrive on volatility should not be disappointed in the week ahead because we have an extremely heavy economic calendar that will tell us whether Federal Reserve Chairman Ben Bernanke was right to be more worried about growth than inflation. The forecasts for October retail sales are low (0.2 percent) because many of the nation’s largest retailers have missed their sales forecasts. However, don’t forget that non-farm payrolls over the past few months have been exceptionally strong and gasoline prices in the month of October remained steady, so retail sales could still beat expectations. Also, we expect both producer and consumer prices to surprise to the upside given the rise in food and energy prices. Does this mean that we are looking for a bottom in the US dollar next week? No. There could be a second half of the week rebound, but over the medium term, we still expect the US dollar to weaken because even if retail sales was strong last month, there is a good chance that holiday sales could suffer. Gas prices could jump at any moment; yesterday we already reported that some gas stations in California are charging as much as $5 a gallon. So the worst is not behind us and a rise in inflationary pressures will only make US consumer spending and the overall US economy more vulnerable to a sharp slowdown in growth. In addition to retail sales, PPI and CPI, we are also expecting pending home sales, the Empire State manufacturing survey, the Philly Fed manufacturing survey, the Treasury International Capital flow report and industrial production.

Green light Still On for the Euro, But Be Careful of What You Buy
Of all the high yielding currencies (which basically excludes only the Japanese Yen and Swiss Franc), the only one that did not fall against the US dollar today was the Euro. Not only is that a testament to the currency’s strength, but it is also a reflection of what could be to come for the Euro. We continue believe that 1.50 is not only possible but probable. Three different ECB officials were on the wires today repeating everything that Trichet said yesterday about inflation and exchange rates. The view within the ECB appears to be very unanimous with inflation a far bigger concern than growth. Weber even said that the level of the Euro is not a factor in their monetary policy decision which can only mean that they don’t care if it strengthens further. Of course, there will be a point when they do care, but that may not be until the Euro surpasses 1.50. With Trichet’s comments this past week, the green light stays on for further Euro strength. In the week ahead the Eurozone economic calendar is comparatively lighter than the US calendar. We are only expecting the ZEW survey of analyst sentiment, German and French GDP and Eurozone consumer prices. Given that US retail sales and inflation data are due for release, the better buy next week may be the relative strength plays over than the EUR/USD itself, such as EUR/GBP or EUR/CAD.

USD/CAD: Time for a Bottom
We had first talked about the potential for a USD/CAD bottom on Wednesday, when we reported a drop in open and long positions in USD/CAD according to the FXCM Speculative Sentiment Index. Now that we have fundamentals and technicals also signaling a potential bottom, the case is even stronger. Canada’s trade surplus fell to the lowest level since December 1998, as a strong currency increases imports and hurts exports. The government is also becoming increasingly worried about the strength of the loonie with Prime Minister Harper expressing concern over the rapid rise in the Canadian dollar while Quebec’s Prime Minister called for a special meeting to discuss the currency. Technically, we have unveiled an interesting 9-week trading anomaly that calls for in sharp rally in USD/CAD in the very near future. Leading indicators, new motor vehicle sales and manufacturing shipments are due for release next week and we expect all of them to be bearish for the Canadian dollar. As for the Australian and New Zealand dollars, they are both sharply lower. AUD/JPY dropped 500 points today. Risk aversion should continue to drive price action next week since New Zealand retail sales is the only piece of potentially market moving data from these two countries.

British Pound Hit By Sharp Rise in Trade Deficit
Even though the British pound hit a new 26-year high today, it collapsed sharply on the back of much weaker than expected trade numbers and overall liquidation out of high yielders. We warned yesterday that given the lack of strong UK data to back the recent rise, any sign of weakness would lead to a sharper slide in the GBP/USD than the EUR/USD which was exactly what happened today. Next week the British pound will continue to be in play with inflation, labor market and retail sales numbers on the calendar. Inflation is expected to be strong and the labor market is expected to hold steady, but retail sales could suffer.

Meltdown in Carry Trades Could Last
Rising risk aversion has led to broad-based weakness in carry trades. The market is growing more concerned about the financial sector with the latest speculation being focused on Mizuho Financial Group in Japan which could be delaying their brokerage merger because of sub-prime losses. The spread between Junk rated corporate bonds and US Treasuries rose beyond its August high when risk aversion was already very severe. Given that the Dow closed at its session lows, we expect follow-through weakness in the yen crosses at the open of Tokyo trading on Sunday. GDP, CGPI and the Current account are due for release, which we expect to be yen positive.

Kathy Lien is the Chief Currency Strategist at FXCM.