Dollar: 1.50 Inevitable?
Dollar dumping continued this week as EUR/USD reached yet another record high of 1.4749 and talk on the dealing desks turned to the psychologically important 1.50 figure. Certainly the greenback has few friends these days, as markets remain convinced that the repercussions from the blowup in the subprime sector will continues to weigh on both the financial industry and the US consumer, forcing the Fed to continue easing well into 2008 which in turn will make the dollar even less attractive to foreign investors.

That theme was reinforced this week after Cheng Siwei, vice chairman of the National People's Congress stated that China should invest its nearly $1.5 Trillion of FX reserves in stronger currencies. The FX market instantly interpreted the remarks as a sign that the Chinese will begin diversifying their currency assets away from the greenback and pushed the dollar to new lows. As we noted on Wednesday,” Although, Mr. Siwei has a history of making broad economic comments that often do not reflect actual policy, and although the National People’s Congress is not involved in directly setting currency targets, today reaction speaks volumes about the extent of anti-dollar sentiment present in the FX market right now.”

Yet with the market fixated on the 1.5000 figure the EUR/USD may necessarily reach its mark. Positioning in the pair is beginning to reach extremes on the IMM, although our own SSI index shows more room to go. Just as oil failed to hit $100/bbl, the EUR/USD may do the same for no other reason than simply because everyone expects it to do so. Next week US Retail Sales and the TIC data will be the pivotal releases on the docket. With markets so uniformly dour on both the US consumer and foreign inflows into the US, positive surprises in the two releases could finally trigger a rebound in the greenback. On the other hand, further negative data will only embolden dollar bears and a run at the 1.5000 level could become a distinct possibility regardless of skew in sentiment.

Euro – Will Sour Sentiment or Hot CPI Drive Direction?
There was little doubt that the European Central Bank would leave rates steady at 4.00 percent last week, but ECB President Jean-Claude Trichet's hawkish tone during his monthly press conference helped keep EUR/USD bid. In Trichet's commentary, he indicated that the central bank was very worried about inflation, but stopped short of using the phrase "strong vigilance," which is his key term to suggest an impending rate hike the following month. At the same time, Trichet said that oil and commodity prices could weigh on growth, and that uncertainty surrounding the ongoing reappraisal of risk in the financial markets prevents them from making policy adjustments at this time. As a result, it has been made clear that the ECB wants to wait to gauge the status of the financial markets before deciding what to do next with interest rates, so traders are not expecting a move in December. However, additional signs that CPI is accelerating much faster than the ECB's 2 percent target rate will keep Trichet & Co. on edge.

Looking ahead to this week, price action in EUR/USD is unlikely to be determined primarily by economic data out of the Euro-zone as the pair remains the domain of dollar sentiment. Nevertheless, traders should watch European releases for indications that the ECB may change their stance going forward. The ZEW surveys for both the Euro-zone and Germany are expected to show that investor sentiment soured in November amidst instability in the financial markets and concerns that the ECB will eventually hike rates again. On Wednesday, third quarter GDP figures for the Euro-zone are forecasted to be revised up to 2.6 percent, reflecting a pick up from the 2.5 percent pace in the second quarter. On Thursday, CPI is likely to be released in line with the initial flash estimates at a pace of 2.6 percent, well past the ECB's 2.0 percent target. Overall, fundamental releases at the end of the week could support the case for additional EUR/USD gains, but the pair may find itself correcting lower first.

Yen Reaps the Benefits of the Carry Unwind – More to Come?
Global equity market declines allowed the Japanese yen to gain over the course of the week, but pairs like USD/JPY and GBP/JPY saw their sharpest moves on Friday on a flurry of carry-trade-unwinding news. First, the yen benefited from news that the People's Bank of China will "strengthen the coordinated use of interest rates and the exchange rate to help stabilize expectations of inflation," suggesting that the country would allow the Chinese yuan to become more flexible and appreciate far more rapidly, as foreign governments – including the US – have been aggressively pushing for. Also, the Nikkei closed down 1 percent on Friday – the sixth straight losing day – on reports that Mizuho Securities may have lost as much as 100 billion yen as a result of the problems in the US subprime mortgage market. As if it wasn't already clear before, the contagion of the US housing market collapse has the potential to spread not only throughout the US economy, but also into global financial markets as we've already seen exemplified in the UK with Northern Rock. Japan was previously thought to be relatively shielded from subprime risk, but evidence is starting to indicate otherwise and dramatically increases the downside risks for growth in the economy.

Looking ahead to this week, risk aversion will likely remain the primary driver for the Japanese yen. Last week we saw junk bond spreads widen quite a bit, highlighting just how jittery the markets have become. Conditions such as these are not likely to fade quickly, creating the potential for additional carry trade unwinding and gains for the low-yielding yen. Economic data out of Japan may jive with such moves, as domestic CGPI and GDP figures are both expected to rise, suggesting that slowly percolating inflation pressures and economic growth will give the Bank of Japan more leeway to consider normalizing rates further. As a result, the combination of risk aversion market-wide and fundamental impetus could push USD/JPY down towards 108.00 by the end of the week.

UK Event Risk Picks Up as 26-Year Record Fades
The UK economic calendar was relatively spotty last week, but the fundamental impact from the mix was potent enough to drive GBP/USD to within arm's reach of 2.12 and turning the pair back for a 150-point-plus retracement. Looking at the beginning of the period, the pound’s continued run against the benchmark dollar was aided by both a strong anti-dollar trend and favorable, second tier indicators, though, on Monday, the diversification out of dollars was struggling to keep the pound above 2.08. That morning, a service sector activity indicator for October marked its worst reading since May of 2003 while a September industrial production marked a 0.4 percent decline – matching the biggest monthly decline in 17 months. From there, the calendar was once again backing the British currency. The BRC reported a respectable 3.0 percent increase in the retail sales over the year through October, while also marking a significant acceleration In the annual shop price index. Rounding out the week’s bullish data, the Nationwide consumer sentiment survey suggested confidence held up last month despite financial market troubles and rising costs.

The subtle turn to cable selling began on Thursday. The HBOS house price indicator for October stirred the fundamental ranks when it reported the a second month of falling prices, the first back-to-back deflation trend in two and a half years. With the housing sector already showing signs of stumbling from its record high activity, this indicator was an unwelcome addition to the docket; however its impact would be forestalled by an impending BoE rate decision. When the announcement passed without a change in lending rates or a statement from the MPC, it was back to cold, hard data. To finish out the week, the leading indicators composite index for September laid out projections of slowing growth with its third consecutive negative month. Equally discouraging, the trade balance for the same month marked its biggest deficit on record. Though the shortfall owed largely to US trade, this merely highlights a large dependency on EZ demand. Should demand from the major European economies cool, exports may turn into a major burden for the old-world economy.

Looking out over the scheduled event risk for this week, the fundamental currents will only intensify. Inflation reports will kick the week off. The PPI numbers will act as a barometer for raw material costs and producers’ ability to pass higher costs onto the consumer. Following that, the DCLG and RICS house price numbers will further highlight the stress in the once stalwart sector, while the CPI and RPI data will define speculation on monetary policy. From there, the employment, earnings and retail sales data will give an objective, well-rounded view of the consumer health. Finally, the BoE’s quarterly inflation report will give us early insight into the central bank’s outlook for monetary policy well before the minutes cross the wires.

Will the Swiss Franc Lose its Luster this Week?
Like the Japanese yen, the oft-forgotten Swissie also benefited from the drop in carry trades late last week, as well as from the release of the SECO Consumer Climate index. The quarterly release was stronger than expected at 15 as tight labor market conditions offset the woes of the financial markets as domestic sentiment remains positive. Indeed, while the Swiss franc has appreciated quite a bit against the US dollar, the currency has actually depreciated against the Euro over the past year. The Euro-zone is by and large Switzerland's biggest trade partner, so this has helped fuel export demand along with the rampant hiring that has driven the seasonally adjusted unemployment rate to a five-year low of 2.6 percent. The EUR/CHF price action has also fueled upside import inflation risks for the economy, and given these buoyant conditions, the Swiss National Bank is likely to continue with their rate normalization cycle in December.

Looking ahead to this week, the status of the greenback and carry trades will largely determine price action for the USD/CHF pair as event risk remains relatively thin. Indeed, the pair remains firmly within a downtrend, and with weakness in the US dollar one of the primary forces pervading the FX markets, there is little reason to fight it. However, there are signs that the greenback could garner a bit of strength this week, so traders should watch for a short-lived turn. The releases of the Swiss ZEW survey and retail sales shouldn't make waves for the Swissie pairs, as neither release tends to be remarkably market-moving. Nevertheless, domestic conditions remain relatively resilient, so the data is likely to indicate broad confidence and solid consumption growth.

USD/CAD Sees its First Serious Rebound in Months
The Canadian dollar closed out a new weekly low against its US counterpart last week, but this high time frame doesn’t do justice to the volatility this pair experienced last week. Looking at any chart with a daily frequency or lower reveals the true action for the Canadian currency. Over the first half of the period, USD/CAD plunged an additional 300 points – adding to previous weeks of unimpeded loonie advance. However, just as 0.9050 came into sight, the initiated its largest rebound since last July. The turnaround came through a consistent effort to jawbone the currency higher from key Canadian policy makers and a clear downturn in a number of the economy's more important indicators. Over the past weeks and months as USD/CAD parity has come and gone with hardly a dent in momentum, politicians and monetary policy makers have stepped up their efforts to pull the currency back through press junkets and official statements. From the Bank of Canada, Senior Deputy Jenkins gave a gloomy reading on what the economy can expect in the months ahead. He said if the Canadian dollar held its highs, it would pose significant downside risk to growth. When asked whether intervention is possible, he did not deny the possibility but merely said that to be effective it would need to be followed up by policy changes. Moving along, Prime Minister said the loonie’s advance was unprecedented ‘by any standard’ and would require ‘reflection.’ Finally, Finance Minister echoed the BoC’s concerns by saying the currency is ‘bearing the brunt” of the US dollar’s slide and that he was ‘concerned’ that the exchange rate could threaten exports.

From the docket, the scheduled data added fuel to the jawboning for a one-two punch. The loonie’s ascent was protected for the first half of the week as a modestly disappointing building permits report released on Tuesday was offset by an unexpected pickup in the Ivey PMI for October. The business activity gauge stepped up to 57.1 despite the unfavorable trade setting, but most of the improvement was in employment, while deliveries actually dropped. On Thursday, the data turned from modestly bad to outright disappointing. Housing starts through October dropped from a record high to a six-month low, while new home prices for the previous month missed its consensus with a tepid 0.3 percent advance. The worst was saved for last. According to Statistics Canada, the International Merchandise Trade Balance for September took a big hit, leaving the gauge with its smallest surplus since December of 1998 – thanks to the burdensome currency.

Looking ahead, scheduled event risk from Canada will play a small role in the loonie’s direction. Leading indicators and manufacturing shipments are merely understudies to more important indicators. Instead traders will derive direction in USD/CAD from commodities, scheduled US event risk – like retail sales, which will be a proxy of US demand for Canadian goods – and pure sentiment. With USD/CAD already on the mend, the more even numbers the pair can overtake, the faster momentum will build behind a rebound.

Australian Dollar Eases from 23-Year Highs
The Australian dollar finished the week lower despite setting fresh 23-year peaks in the early going, as a sharp return to risk aversion sunk high-yielding currency pairs against their lower-yielding counterparts. The currency’s yield advantage nonetheless improved on a mid-week Reserve Bank of Australia interest rate hike. Given a 25 basis point rate increase, short-term rates of 6.75 percent make the Australian dollar the fifth-highest yielder among all major currencies. Such a shift should make it more attractive to investors looking for the highest return on capital, but it nonetheless remains clear that recent market skittishness bodes poorly for popular carry trade-linked currencies. Short-term price action will subsequently depend on whether global risky asset classes recover from their recent stumbles—especially as the Dow Jones Industrial Average closed over 500 points lower from the week’s open. A significant deterioration in US credit market conditions may preclude a significant Dow rally, however, and leaves doubts as to whether carry trade currencies can post a significant recovery in the week ahead.

A relatively limited week of Aussie event risk leaves the currency to the will of broader market forces, but traders should be mindful of surprising statements from the Reserve Bank of Australia’s Quarterly Monetary Policy Statement. Though we have already listened to official RBA commentary following its recent rate hike, the bank will give a much more in-depth picture of its outlook on growth and inflation in Sunday night’s communiqué. Central bankers remained relatively hawkish in their post-hike statement, and they predicted that inflation would remain at the top of their comfort range of 2-3 percent through mid-2008. Though officials expressed concern over recent financial market difficulties and a clouded global economic outlook, the inflation-targeting body is fairly likely to continue raising interest rates if price pressures persist. That said, it will be important to watch for any (admittedly unlikely) shifts in rhetoric or tone in the Quarterly Statement on Monetary Policy. Otherwise, Aussie traders will watch the performance of global risky asset classes, and continued volatility would do little to boost the currency from recent lows.

New Zealand Dollar to Depend on Dow Jones Industrials for Rebound
Risk-averse currency traders forced sharp sell-offs in the New Zealand dollar, as it fell a substantial 330 points—or 3.7 percent—against the resurgent Japanese yen. The kiwi likewise finished lower against its downtrodden US namesake, and a substantial intra-week reversal leaves doubts as to whether it can post a substantial recovery through short-term trade. Mixed economic data did little to help the currency’s chances, especially as employment change figures showed a net loss of jobs through Q3, 2007. The domestic unemployment rate nonetheless fell to record lows through the same period; falling labor market participation led to an arguably deceptive drop in joblessness. A simultaneous labor costs result showed stronger-than-expected inflation, but it is subsequently unclear whether this will lead to a notable shift in sentiment from the Reserve Bank of New Zealand. Indeed, forecasts of potential interest rate cuts from the RBNZ leave it at a very clear disadvantage against its Australian counterpart. The Aussie continues to trade near 14-month highs against the Kiwi on a fast-shrinking yield differential.

Limited economic event risk will leave the New Zealand dollar to trade off of shifts in global risk sentiment, and a recent carry trade rout leaves momentum to the downside for the popular high-yielding currency. With the highest short-term interest rate of any country with a top S&P Sovereign debt rating, New Zealand’s currency clearly stands to gain on renewed demand for high-yielding currencies. Yet such carry trade popularity is clearly a double-edged sword. Wide-scale liquidation of risky assets almost always sends the NZD sharply lower. We subsequently look to general market risk appetite for clues on all NZD-denominated pairs. A clear deterioration in US credit market conditions threatens to sink the domestic stock market to fresh depths, and markets will need to recover if the Kiwi stands any chance of rebounding from recent lows. Otherwise, forex speculators will watch mid-week Retail Sales figures to gauge consumption strength for the New Zealand consumer. Any sharp surprises could easily drive volatility across all NZD pairs.

Boris Schlossberg is a Senior Currency Strategist at FXCM.