Dollar Weakens Despite Clear Fed Warning on Interest Rates
The US dollar faltered through end-of-week currency trading, as a marginal improvement in risk appetite and disappointing economic data combined to sink the greenback against major forex counterparts. Morning Treasury International Capital data sparked the renewed dollar sell-off, as a mere $26.4 billion in net foreign investment entered the US through the month of September. Given consensus forecasts of a $60.0billion gain, the result was hardly enough to quell fears of further foreign divestment of US financial assets. As if traders need more reason to sell the US dollar, the subsequent Industrial Production report likewise printed sharply below median predictions. Overall industrial output shrunk by the most in six months, dragged lower by a sharp pullback in the production of consumer goods. It seems as though domestic producers believe that overall consumption levels will drop markedly in the months ahead, and the simultaneous Capacity Utilization figure fell to four-month lows of 81.7 percent. Such dismal consumer-linked figures hardly came as a surprise to economists predicting a further US economic slowdown, but it is interesting to note an apparently overlooked speech by Fed Governor Randall Kroszner on growth and US interest rates. The Fed official spoke of the central bank’s decision to cut rates in September and October and made it fairly clear that he does not believe further rate cuts will be necessary given recent economic developments. Yet Fed Funds Futures for December remained almost exactly unchanged on the day, and traders predict an 86 percent chance that the FOMC will vote to cut rates by 25 basis points at their December 11 meeting. Kroszner’s speech serves as a clear warning that financial markets are overshooting the probability of further rate cuts in the months ahead. Though the dollar remained unchanged in the wake of his comments, it will be important to see how this all plays out in the days ahead. Shifts in interest rate expectations could only boost the downtrodden greenback against foreign counterparts.

Euro: Look to Sunday’s Nikkei and Hang Seng Performance
The Euro remained subdued through overnight Tokyo and morning European trade, but the later dollar sell-off left the single currency effectively unchanged at the week’s close. Economic data was limited out of the Euro-Zone, with a largely ignored Trade Balance falling roughly in line with forecasts. An earlier French Non-Farm Payrolls release was likewise uneventful, and it was clear that risk sentiment was the main driver of euro price action. It was unsurprising to see the EUR fall sharply on a 4 percent rout in Hong Kong’s Hang Seng Index, and a 0.7 percent drop in the DAX hardly helped the euro’s case. Yet the surprisingly positive close in the Dow Jones Industrial Average leaves intraday momentum in favor of further Euro rallies. It will be critical to see whether or not Asian markets can recover from their dismal end-of-week performance, and Sunday night/Monday morning will likely bring further volatility to all EUR pairs.

British Pound Closes Its Worst Week Since the August Credit Crunch
A fully stocked fundamental calendar tapered off into the end of the week with no indicators scheduled for release Friday. The market clearly needed the break, as shorts took the opportunity to take profit, allowing GBP/USD to close on an up day. However, despite Friday’s modest recovery, the damage was already done. The 385-point loss over this past week was the largest since the decline through August 17. As you may recall, that Friday’s low marked the end of a nearly 1000-point sell that began in July when the now infamous credit crunch took hold of the market. Looking over the newswires for today, while there were no indicators, there were a few notable headlines. In his quarterly press conference, BoE Governor Mervyn King joined US Treasury Secretary Henry Paulson and ECB President Jean-Claude Trichet in demanding China to allow its currency to strengthen more quickly. Also, the Nationwide Building Society released a forecast for zero housing price growth in 2008, setting an ominous tone for Sunday evening’s Rightmove survey.

Com Bloc Takes a Breather from Risk Aversion Trends
The Canadian, Australian and New Zealand dollars all rose modestly through the close of Friday’s session. Initially, the commodity bloc’s association to risk was weighing the group down with the Hang Seng’s plunge threatening another wave of selling. However, when the European and North American bourses came online, it became clear that risk aversion would not act up into the weekend. The Canadian dollar made a notable, yet choppy advance into the weekend. Volatile energy prices helped the currency win hard fraught gains with crude up 1.9 percent and natural gas rising 3.9 percent. However, the commodity link could soon fade into the background, if the credit crunch further seeps into the Canadian economy. This morning Bank of Montreal announced a C$210 million writedown on debt related losses.

Risk Trends on Hold for G20 Meeting
This week has been a relatively choppy one for the risk-tied Japanese yen. The USD/JPY closed the Friday session out lower against the benchmark dollar as market participants looked ahead to this weekend’s G20 meeting and the following week’s low-liquidity. First things first, the members of the G20 will meet near Cape Town to its usual fair. However, not everything will be routine. In recent days, a number of monetary officials across the world’s major economies have begun to speak up on currency concerns. Just today, the usually mum BoE Governor King joined US Treasury Secretary Henry Paulson in calling for a stronger yuan. Elsewhere, BoJ Governor Fukui suggested he was uncomfortable with the yen’s recent, rapid appreciation. Clearly, there will be a push to bring problems over the exchange to the table. From the economic calendar, only the final reading of the September Leading Economic Index was on tap. The Leading figure held at its decade low.

Kathy Lien is the Chief Currency Strategist at FXCM.