Dollar at a Standstill – Which Way Next?
Was it a pause that refreshes or a sign of an intermediate term top? Dollars bulls and bears battled each other to a standstill as the pair tried but failed to make a new record high. On the other hand any attempts to take it lower were met with steadfast bids. As we noted earlier in the week, ‘the market remains resolutely dollar bearish, keeping any retracements in the EURUSD relatively shallow. Only if the EURUSD breaks below the important 1.4500 figure will we have confidence that a serious correction in the pair has commenced. For the time being the market continues to give the benefit of the doubt to the ECB while expecting the Fed to steadily lower rates. “

The greenback is beginning to suffer from another problem. Up until very recently US was able to attract enough foreign capital to offset its massive trade deficits, but last months TICs data shattered the complacency of the market when it printed at -$69 Billion versus forecasts of $65 Billion surplus. This months data didn’t do much better printing only $26.4 Billion against $71.5 Billion forecast. If foreign capital flows are indeed drying up the long term structural implications for the greenback are very negative. Friday’s announcement by UAE that it is considering a replacement of the dollar peg with a broad currency basket could only be that start of a massive move away from the dollar as the reserve currency of the world.

Next week, holiday thinned trading should keep price action contained, but the buck faces more challenges as the calendar is chuck full of housing data which is expected to be dour yet again. The one thing that may boost the greenback could be the release of the FOMC minutes, assuming they are hawkish in tone. At this point conventional wisdom expects another rate cut from the Fed in December. If the committee signals that it will remain stationary, the dollar may get a reflexive bounce. Overall, however, the momentum is still with the bears.

Euro – Hitting a Wall
Despite record high exchange rates, the news from the EZ this week was generally positive. GDP printed slightly better, aided by growth in investment, and Trade Balance registered a bigger surplus than market projections, providing euro bulls with plenty of evidence that the region’s economy continued to show strength. But as we noted on Friday, “For the time being it appears that the European industrial sector is able to absorb the high exchange rate differential and maintain its competitiveness. However most recent manufacturing surveys shows signs of decline that will likely result in a material slowdown in demand if the pair continues its relentless march upward.

Furthermore, the region’s trade deficit with China is becoming progressively unbalanced widening to 70 Billion euros this year. According to Bloomberg, an EU delegation led by ECB President Trichet is expected to tell the Chinese authorities at the end of the month that risk of a protectionist measure would increase markedly if China does not revalue the yuan. In short, despite the relatively robust EZ economic environment, EZ monetary policy makers face tremendous political pressure to not exacerbate the current exchanger rate situation by raising rates further. Given that dynamic the currency market may begin to downgrade the prospect of any additional rate hikes from the ECB in Q1 of 2008.”

Next week, the most important data for the EZ will take place at the end of the week when the US is in holiday. The flash PMI readings for the region will be released and while the services sector should remain well above the 50 boom/bust line, the key for the market will be manufacturing. If manufacturing does slip into contraction the pressure on ECB to hold rates steady will grow exponentially and that may stall any further EURUSD rally for the time being.

Yen Rally Stumbles On Data Mix, Fukuda Comments
The yen was loosing its grip on the worldwide and asset-wide wave of risk aversion last week. Looking across equities, commodities and currency markets, the move against risk was clearly winded – this despite considerable volatility in LIBOR rates and significant premiums in credit markets. However, the ebb and flow of risk appetite wasn’t the only thing impacting price action in the Japanese currency last week. The headlines were spotted with remarks made about foreign exchange by notable Japanese officials. BoJ Deputy Toshiro Muto said Japan would suffer from the US housing slump and lingering financial-market turmoil. He also said the dampening influence these additional burdens to the economy would make it ‘difficult’ in deciding to raise rates. This was the same tone the BoJ’s minutes for the October 11th meeting took. Once again an 8-1 vote (Mizuno was once again the dissenter, favoring a hike) accented an increasingly dovish outlook. And, stealing the show, green Prime Minister Fukuda even added his own two cents by suggesting the yen was rising far too fast.

Altogether, the commentary for the week was clearly tilted in the bears’ favor, but data was more of a mix. The docket opened strong with a 10-month high 2.4 percent pace of growth in the October wholesale inflation gauge. The more impressive indicator though was third quarter GDP which put in for a bigger than expected rebound from the biggest annualized drop in growth in six years. An unexpected pickup in consumer spending push the gauge up to a 2.6 percent clip. From there the fundamentals went down hill. An October consumer confidence gauge hit a three-year low; while a September service sector activity report and final reading for the Leading indicators index hit six month and 10-year lows respectively.

The fundamental winds will die down next week, exposing the market to the potential of unexpected and exogenous event risk. On the docket, we will see the secondary Nationwide Department, Tokyo Department, Convenience Store and Supermarket sales reports for October; but not the far more consequential retail trade figure. The All Industry Activity index and merchandise trade numbers will be the top indicators for the week, yet they are often overlooked completely. Though there is no easy consensus tied to it, the weekend’s G20 meeting could finds some follow through for the Japanese currency should the yuan, dollar or yen splash the headlines. Aside from that, the sapped liquidity from the US this week could stoke large moves should risk trends take a shock and leverage volatility.

Cable Plummets as BOE Turns Dovish – More Losses To Come?
Despite a surprise surge in inflation above the Bank of England's 2.0 percent target early last week, the central bank's Quarterly Inflation Report proved to be surprisingly dovish and did little to put the breaks on Cable's 1.8 percent slide. The BOE said that inflation risks are 'balanced' and with GDP growth likely to slow 'sharply' in 2008, CPI is forecasted to settle at 2.0 percent. These comments are decidedly neutral, but the dovish kick came as the BOE's forecasts were assuming at least one rate cut in 2008. This was somewhat contradictory to the market's perceived bias beforehand. With oil and other commodity prices rocketing to record highs, there are well-warranted concerns that global inflation will rise significantly. The prospect of increased price pressures only compounds the problems that the Bank of England already faces as they contend with mounting downside risks to growth and uncertainty surrounding the ongoing reappraisal of risk in the financial markets. Indeed, it appears that Bank of England Governor Mervyn King has started to fold under pressure after taking quite a bit of flak following the run on Northern Rock in September, as critics say that he failed to help the situation when he refused to provide extra liquidity amidst the rapid tightening of the credit markets. In fact, King – an ardent inflation hawk that is strongly against increasing the risk of moral hazard – left the UK's benchmark lending ready steady at 5.75 percent for the fourth consecutive month on November 8th, as more accommodative monetary policy would only fan price pressures. However, it is starting to become clear that the bank will probably cut rates by 25bp to 5.50 percent in the first quarter of 2008, which will do little to reignite a bid for the British pound.

Looking ahead to this week, fundamental data may only underpin the case for further sell-offs of Cable. First, the Rightmove house price index is likely to reflect a slowdown for the sector, as the Nationwide Building Society recently released a very gloomy forecast for zero housing price growth in 2008. Given the rapid appreciation of properties in the UK and subsequent decline in affordability, combined with the BOE's monetary policy tightening throughout 2007 will certainly put a drag on demand for housing. The question is: will it be a US-style housing crash or a mild slowdown? Unfortunately, this will be more of a "wait-and-see" matter for the central bank, but could also serve as yet another reason to cut rates in early 2008. The minutes of the BOE's most recent meeting is likely to highlight the bank's concerns and echo much of the sentiment in the Quarterly Inflation Report, but the market-moving piece of information will be the vote count, as just a few motions for a rate cut could rapidly push Cable to break down through support at 2.0350.

Swissie Remains the Leader on Stellar Economic Conditions
The Swiss franc was one of the only currencies to gain against the greenback last week, though the USDCHF generally remained contained to a range. Nevertheless, data out of Switzerland highlights just how stellar the European economy is. Retail sales jumped a seasonally adjusted 7.1 percent in September from a year earlier - the strongest reading since May - as consumption and domestic demand remains resilient. Indeed, with demand for Swiss goods from the Euro-zone continuing to grow, especially as the Swiss franc has weakened throughout the year against the Euro, the boost in output has led producers to hire on additional workers. As a result, the Swiss unemployment rate has dropped to a five-year low of 2.6 percent and has helped drive wage growth, encouraging households to spend. The data suggests that Q3 GDP figures should prove to be quite healthy, though the SNB has recently been concerned about downside risks to the economy in 2008. Regardless, the broad based strength in the economy along with the potential for import price inflation should keep the SNB on track to normalize rate further in December.

Looking ahead to this week, the status of the greenback and carry trades will largely determine price action for the USDCHF 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 USDCHF could garner a bit of strength this week as the pair nears support below 1.1100, so traders should watch for a possible turn. The releases of the Swiss trade balance and quarterly employment level shouldn't make waves for the Swissie pairs except for a very brief time, as neither release tends to be remarkably market-moving. Nevertheless, domestic conditions remain relatively resilient, so the data is likely to indicate export growth and tightness in the labor markets.

USD/CAD Losses Mount As Data Fails, Credit Problems Grow
The pull back in the Canadian dollar continues. Against its major counterpart (the US dollar) the loonie slipped another 300-plus points. After this second round of selling, USDCAD was risen nearly 700 points off its record low above 0.9050 set back on November 7th. Looking back over the event risk from this past week, the weakness doesn’t seem too surprising. On the economic docket, there were only three indicators; and each printed worse than the market’s were prepared for. Addressing them in their market-moving hierarchy from bottom to top, the new motor vehicle sales figure for September came in with a slight miss of 2.1 percent decline in new purchases. However, this is a volatile gauge and the more important concerns for forex traders are hard to gauge. The manufacturing shipments report was a little more straightforward – and far more bearish. While the factory report is also volatile, a fifth drop in six months is hard to miss as evidence of waning US demand and eroding competition due to the high Canadian dollar. Finally, the Leading Indicators report for October was the most concerning report of the lot. No change was expected from the original 0.3 percent reading from September, but considerable declines in the housing and new manufacturing orders components pulled the headline reading to 0.1 percent, it lowest level since February of 2005.

Not on the economic docket, but equally market moving, were signs that the economy is catching the credit cold the rest of the world is suffering from and dour comments from policy officials. Bank of Canada Senior Deputy Governor Jenkins let his concerns over the state of exchange rates be known. In regards to the Canadian dollar’s level, Jenkins forecasted a stunted Canadian economy should the loonie retain its heights – though he clearly said he would not intervene. He also said that the ‘rapid and significant’ fall in the US dollar was mixing with the loonie’s ascension to levy a ‘disproportionate’ burden on the Canadian economy. He suggested China and other Asian economies with huge surpluses should make their exchange rates more flexible to take their fair share. And, many still believe that the Canadian economy has weathered the credit crunch that has spread throughout the global economy. However, the BoC’s C$1.57 billion injection in money markets on Thursday (the biggest since 2000) and a C$215 million writedown on debt-related losses at Bank of Montreal suggest otherwise.

In the days ahead, exogenous risk and commodities price action could ounce again guide the Canadian dollar in its burgeoning decline; but not before the economic docket has its crack at the trend. Kicking the week off are the international securities transactions and wholesale sales report for September. After the physical surplus dropped to a multi-year low recently, there is more pressure on investment interest to keep up the necessary inflows to prop the Canadian currency. The wholesale report will merely be a gauge to fine-tune speculation for the later released retail sales report, which is expected go unchanged for the month of September, a concerning outcome for an economy growing ever more dependant on the consumer. Finally, headline inflation is expected to two year highs, but will the BoC listen?

Aussie May to Lose Further Against Yen Unless Stocks Rebound
The Australian dollar continued to falter through the week’s trade, as a carry trade sell-off forced sharp drops in the high-yielding currency. A downturn in global equity markets was the clearest sign of rising risk aversion among international investors, and the Aussie almost always underperforms most major currencies in these trading environments. Indeed, fresh economic developments were mostly bullish , but traders remained focused on the drops in risky asset prices. A strong Wage Cost Index result bolstered the case for further Reserve Bank of Australia interest rate hikes through the medium term, and an earlier RBA Statement on Monetary Policy certainly suggested that the central bank could raise rates further through the coming months. Given forecasts of above-target inflation for much of 2008, it seems likely that interest rates will rise to keep price pressures in check. Yet recent credit market turmoil limits the likelihood of any such tightening through the bank’s December meeting. Australian money market rates remain significantly above official short-term target rates of 6.75 percent, and such credit difficulties effectively make for tighter monetary policy conditions in the domestic economy. Broader credit and lending market dynamics will likely continue to drive the Australian dollar’s performance—especially as the coming week’s calendar promises little in the way of economic event risk.

The Aussie will have to depend on a rebound in global stock markets to regain traction against the lower-yielding US Dollar and Japanese yen. That said, it seems as though risks remain to the downside for short-term performance in global equity indices. We recently argued that disappointing financial conditions and growth prospects would keep these assets subdued through the medium term. The subsequent implications for the global carry trade are relatively clear; risks remain to the downside for the performance of high-yielders against the previously downtrodden Japanese Yen. We will need to see a substantive improvement in financial market conditions to shift our assessment on overall risks on short to medium-term Aussie trade.

New Zealand Dollar to Depend on Dow Jones Industrials for Rebound
The New Zealand dollar slid further on disappointing performance in global equity markets, and overall risk aversion prevented any Kiwi bounces on broadly bullish economic data. The US Dow Jones Industrial Average posted another sizeable weekly decline, and the NZDUSD followed suit. Stronger-than-expected Producer Price Index and Retail Sales figures failed to elicit sustained rallies in the Kiwi. Yet it remains clear that such economic data increases the likelihood of Reserve Bank of New Zealand interest rate hikes in the months ahead. It is a bit premature to call for any such rate changes through upcoming meetings, but PPI figures provide impetus for further rate speculation. Other noteworthy developments included a positive Business Purchasing Manager’s index result—improving outlook on domestic business conditions. Yet such economic considerations will do little to boost the currency if risky asset classes continue to falter through short-term trade.

The Kiwi’s performance will continue to depend on global equity market performance, and any further drops in the Dow Jones Industrial average can only sink the high-yielder further against lower-yielding counterparts. A rolling correlation between the NZDJPY and the Dow Jones remains at an exceedingly high 0.80—underlining the currency pair’s sensitivity to any strong tumbles in the key risk barometer. Relatively limited economic event risk is comparatively unlikely to drive major moves in the Kiwi, with second-tier New Zealand PMI Services and Credit Card Spending likely to be ignored by speculative forex traders. Otherwise, we will watch the relative performance of similarly risk-sensitive carry trade currencies to gauge overall trends in forex price movements.

Boris Schlossberg is a Senior Currency Strategist at FXCM.