Dollar’s Destiny Depends on NFP
Existing Home Sales, Durable Goods, Personal Income and Spending and Consumer Confidence numbers all missed their mark this week, but despite the dour economic news and the gloomy sentiment around the dollar, the greenback managed to gain 130bp on the euro and given the price action on Friday now looks more likely to reach 1.4500 rather than 1.5000. What caused this turn in price? The most important event to drive trade last week wasn’t on the economic calendar. Rather, it was the announcement by the Abu Dhabi investment authority that it was willing to inject 7.5 Billion in Citibank which caused a turn in sentiment providing a boost for the buck. The Abu Dhabi news suggests that foreign capital investment may not leave US but will rather be redirected into equities instead of fixed income assets. For the greenback which has been reeling partly on the fears of massive foreign capital outflows this was welcome news indeed.

Last week we noted that, “there is no doubt that the pair wants to target 1.5000 again … but it will have to do so with more substantial reasons than mere stop running.” This week the moment of truth may be upon us. The US calendar is chuck full of important data including ISM Manufacturing and ISM Non-Manufacturing surveys, both of which are expected to be softer than last month, though still above the 50 boom/bust line. Dollar’s destiny however, is quite likely to be determined by Friday’s NFP data. The bears argument has been predicated on the assumption of an imminent recession in the US, but until and unless the jobs data shows clear deterioration there is little evidence that the US economy is in serious trouble. Last Thursday’s weekly jobless claims which jumped by 10% certainly provide little cheer for dollar bulls, but the ultimate decision on the direction of the pair will be governed by next Friday’s data. If the NFPs can expand by 100K or more the talk of doom and gloom may be overdone.

Euro – No Hike in Sight
One of the reasons for the decline in the EUR/USD, aside from the dollar positive Abu Dhabi news last week, was the changing market perception regarding EZ interest rates. As we noted on Friday, "The market is beginning to understand now that there is very little upside potential to eurozone GDP going forward, which ultimately is not going to result in higher interest rates. Even if the U.S. lowers their rates in December it's very unlikely that the ECB is going to increase rates any time soon. The euro is losing some of its buoyancy because of that."
With German Retail Sales dropping a whopping –3.3% on a month over month basis, while EZ Retail PMI continues to sink further below the 50 boom/bust line to 45.9 the European monetary authorities are unlikely to exacerbate the situation by making credit tighter. No doubt last week surge in M3 data which increased to 12.3% from 11.5% the month prior along with better than expected IFO data gave euro bulls reason for hope, but the fact of the matter is that European economy appears to be bifurcated, with producers continuing to do well, but consumers lagging badly. Under such circumstances the ECB is likely to remain sidelined for the time being.

Nevertheless, next week, all eyes will be on Jean Claude Trichet as the ECB chief takes the podium in the post announcement press conference. While no one expects the ECB to hike rates on Thursday, traders will be listening with care to Mr. Trichet’s words. The ECB does not like to surprise the markets and usually forewarns a month in advance as to its policy intentions. If Mr. Trichet sounds the alarm by using the word “vigilance” and focusing on the elevated levels of inflation, it would suggest that the ECB will tighten at the start of next year irrespective of the weak consumption in the Eurozone. If, on the other hand, he remains coy vis-a-vis future rate hikes, the EUR/USD could see further pressure to the downside.

Yen Loses Out on Return to Risk – Can this Sentiment Hold?
The Japanese yen softened over the course of last week, as markets became more risk-seeking and brought carry-trades back into play. Economic data out of Japan was mixed, with industrial production and retail sales proving to be better-than-expected. On the other hand, reports from the Cabinet Office and Trade Ministry indicated pessimistic outlooks by politicos. Taking a deeper look at the economic news, industrial production in Japan rose 1.6 percent to a record in October to meet demand from China and Europe, suggesting that a slowdown in the US will not hinder growth in the Japanese economy. However, the data also highlights how critical exports are to expansion in the nation, and while Japanese retail sales for October rose at a better-than-expected 0.3 percent from the month prior, the Japanese Cabinet Office's monthly economic report crushed any positive spin to be made from the releases. Indeed, the office cut its assessment of the labor market for the first time in three years, effectively eliminating one of the Bank of Japan's primary arguments for continuing on with rate normalization. Furthermore, the Japanese Trade Ministry published a survey that showed that 90 percent of small and mid-sized companies were having difficulty passing on higher energy costs to consumers. With inflation unlikely to pick up significantly from wage increases or price hikes on consumer goods, there is little impetus for the central bank to increase rates any time soon.

This week, economic data out of Japan is expected to reflect improvements in third quarter capital spending and labor cash earnings. However, these "improved" figures are also likely to remain negative, with capital spending anticipated to have fallen 2.5 percent from last year while labor cash earnings are predicted to have eased 0.1 percent from a year earlier. Unless capital spending can show a surprising gain – which is unlikely given the worries pervading the business sector regarding the potential global impact of a US economic slowdown – the fundamental picture for Japan remains bleak. Nevertheless, the yen may have an opportunity to gain this week, as risk aversion trends remain the primary driver of the low-yielding currency. As a result, traders should keep an eye on global stock markets, as a plummet in equities could push USD/JPY back down towards 109.00.

Cable Breaks Down on UK Data – Will the BOE Cave and Cut Rates?
While the British Pound did manage to rally for a test of 2.08 last week, there was little to support the gains amidst a deadly combination of soft economic data and dovish commentary from a Bank of England monetary policy committee member. As a result, GBP/USD ended the week down slightly with a break of critical support at 2.06. Indeed, an unexpected drop in mortgage approvals in October to a two-year low of 88,000 along with a 0.8 percent pull back in Nationwide housing prices – the sharpest drop in twelve years – suggests that growth in the UK housing sector has deteriorated. Such results are not entirely surprising, as tighter monetary policy by the BOE and dwindling affordability in the property market were bound to take a toll eventually. These factors, as well as record high energy prices and concerns about the instability of the financial markets has also impacted consumer confidence, as the GfK's sentiment survey fell to a four-year low of –10. The erosion of multiple sectors of the economy has made the BOE quite uncomfortable, as percolating price pressures have thus far prevented them from cutting interest rates. Nevertheless, this has done little to deter BOE MPC members like über-dove David Blanchflower, who was one of the two dissenters in favor of a cut at the November policy meeting. Last week, Blanchflower made clear his intent to vote for a decrease again in December as he said that rates should "come down now so we get ahead of the curve." Whether he and the other dissenter, John Gieve, can garner enough supporting votes for a 25bp cut to 5.50 percent remains to be seen, but there is little doubt that the central bank will make monetary policy more accommodative eventually as the most recent Quarterly Inflation Report included forecasts that assumed on at least one rate cut by the end of Q1 2008.

Will the 25bp rate cut come this week? Unlikely. BOE Governor Mervyn King remains an ardent inflation hawk and with central banks like the RBA still raising rates as commodity prices soar, he may be hard pressed to remind his fellow policy makers of their price stability mandate. Though October CPI readings were relatively subdued, areas like the Euro-zone have seen their November inflation reports rocket higher, signaling that the UK may see similar gains. On the other hand, credit markets remain tight and economic data ahead of the bank's policy decision may suggest that economic expansion is slowly dramatically. PMI for the manufacturing, services, and construction sectors are all forecasted to fall back, but it is the services sector indicator that will likely be watched more closely. The index reading is anticipated to ease back to 52.9 from 53.1, but if the figure falls below the critical 50 level – indicating contraction in the sector – the markets may reconsider whether the BOE will want to take pre-emptive action at the end of the week with a rate cut. Either way, Thursday's BOE rate decision should spark volatile price action for the British Pound.

Swissie’s Fortunes Quickly Reverse Despite Strong Data
Switzerland’s economic data couldn’t miss last week. A number of the country’s top market-moving indicators were crossing the wires; and every single one either beat its forecast, was stronger than the previous month, or both. Ironically, the data grew more important with time. Hence, Tuesday’s producer and import price index was the low point for the week. And, though this figure fell short of its forecast, it was just a tick off its multi-year highs. Hitting the wires later the same day, UBS’s consumption indicator for the same month jumped to a three month high. A rebound in consumer spending is a promising sign for the economy considering credit and financial market turmoil and fading demand from the Euro-Zone and US threaten to temper strong growth trends. The KOF Leading Indicators composite index for November was picking up on the divergent sources of growth in the economy. While the gauge (used to predict growth over the coming three to six months) marked a six-month low, it was able to stave off a drop below 2.0. The heavy-hitting data was reserved for Friday. Simultaneous release of third quarter GDP and November CPI was a potent cocktail for fundamental bulls. The economy grew 0.8 percent over the three months ending with September, boosting the annual figure to its fastest clip this year. The report’s breakdown revealed that neither personal consumption nor exports slowed in the quarter, though fixed investment took a considerable hit – a victim of higher lending rates and tightening credit conditions. The consumer inflation gauge was unquestionable in its support of the currency however, when its annual figure hit a more than six-year high thanks to soaring energy prices. This has likely sealed a quarter point hike from the SNB on December 13.

Despite the strong showing on the fundamental front last week, USD/CHF rallied more than 300 points – in a nearly consistent move. This strong push in the face of such influential data suggests greater forces are at work. Namely, buying interest behind an oversold dollar and a reemergence of risk appetite. It is difficult to forecast the back and forth in the carry trade, but the demand for the US dollar will be tied to an active economic calendar and a GCC summit that may result in a considerable diversification away from the greenback. Looking back to the Swiss calendar for reliable timing on event risk, there will be a few reports that could generate interest from the trading masses. The SVME PMI number will measure the health of the business sector with lending conditions worsening and foreign demand cooling. Thursday’s jobless report will be fundamentally significant, though its steady change month-to-month has made it somewhat impotent.

Canadian Dollar Struggles to Keep Above Parity with Dollar
The Canadian dollar has fallen a long way from its record highs against its US counterpart. Three weeks ago, USD/CAD had dipped below 0.91, extending an incredible, nearly inexhaustible rally in the loonie’s favor. However, from the spike low at 0.9055, a sharp reversal has taken control and nearly every potential foothold the Canadian currency could find along its descent has crumbled away. The commodity pillar has fallen away right on cue with precious and industrial metals falling this past week, while the energy group has seen a substantial pullback. Even Loonie bulls’ favorite crude correlation has become a burden with oil prices having given up on $100 barrel oil on Monday to settle below $89 per barrel on Friday evening. Another exogenous risk that has reared its head for the com bloc regular is the infectious credit crunch. While strong labor and consumer spending trends, as well as export activity, have crowded headlines; the economy has not been immune to the rough financial seas. The Bank of Canada has quietly injected its markets with liquidity over the past few weeks while Canadian bankers are still have trouble pricing credit instruments.

Adding to selling pressure this past week was the tepid economic calendar. There were a few notable indicators crossing the wires and each came with a disappointing slant. The least market-moving figures were the industrial product and raw material price indexes for October, both of which reported weaker than expected figures and further depressed expectations for building inflation pressures for the BoC to respond to. Looking at the real market movers, we had the third quarter current account and GDP reports. Exports, a vital component of growth, was clearly fading as the broadest measure of trade reported a C$1.0 billion surplus – its smallest four years. The domestic growth report was a mixed bag as the figure outpaced expectations of a deceleration to a 2.1 percent pace, yet the 2.9 percent clip was still a cooling from the previous period. What’s more, forecasts for fourth quarter expansion are still aiming low.

Looking out over the week ahead of us, the market has built pressure into USD/CAD returning to parity. Now, the market will wait to see whether this level can be a launching point for a substantial move. Certainly, commodities will play their part once again, with a close eye being kept specifically on crude oil and its derivatives. What’s more, the economic calendar could be an even bigger player in price action this time around than it was last week. To start things off, the BoC will announce its rate decision on Tuesday, though it does not usually release commentary when policy officials don’t change the target (which is what is expected). Both building permits and the Ivey PMI number will be interesting in the long run, though it will be the employment data which holds the keys to sharp Canadian dollar moves.

Aussie Awaits RBA Rate Decision
The Australian Dollar gained for the worst week in three, as a sharp improvement in global risk sentiment led to a substantial rebound in forex carry trade pairs. The Aussie was the second-strongest performer across the G10, just narrowly behind the New Zealand dollar on clear demand for high-yielding currencies. Fresh economic developments were relatively lackluster for the currency, however, with Private Capital Expenditure and HIA New Home Sales both strongly below consensus forecasts through the period. Capital investment in the domestic economy fell a surprising 6.5 percent through the third quarter—its worst performance since Q2, 1999. Yet analysts claim that the private survey overstates the drop, which contradicts robust construction spending figures through the same period. According to one major Australian bank, an estimate for final Capital Expenditures through 2007 leaves nominal investment growth at a healthy 13 percent. Third quarter figures suggest that the pace of investment will slow through the medium term, but economists are not overly concerned with the nominally disappointing result. Economic outlook for the Asia-Pacific economy will likely become clearer in the week ahead, with a steady stream of economic event risk to potentially drive major volatility across AUD pairs.

All eyes will turn to significant event risk leading up to Tuesday’s Reserve Bank of Australia interest rate decision and Gross Domestic Product report, with Trade balance and Retail Sales figures likely to influence sentiment ahead of the key releases. Analysts predict that Retail Sales grew at a 0.6 percent pace through the month of October, as a robust labor market and strong consumer sentiment boost spending. Indeed, strong wage price pressures and consumer demand were behind the Reserve Bank of Australia’s decision to raise rates to 6.50 percent through their last meeting. Though analysts expect the bank will leave rates unchanged through their upcoming December announcement, there remains a very real risk that rates will continue to rise through upcoming months. All 27 analysts polled by Bloomberg News expect unchanged rates at the December 4 meeting, in which case the RBA would not release commentary following the result. Yet a later Gross Domestic Product figure is likely to force noteworthy volatility across Australian dollar pairs.

New Zealand Dollar Rallies Ahead of RBNZ Rate Announcement
The New Zealand dollar was the best performer among all G10 currencies, as improving risk appetite pushed traders to bid up popular high-yielding NZD pairs. As the currency with the highest short-term interest rate of any country with S&P’s top sovereign debt rating, the New Zealand dollar unsurprisingly gained the most from the renewed carry trade demand. Recent economic developments hardly boosted the currency’s prospects, however, as Trade Balance, NBNZ Business Confidence, and Building Permits were all worse than expected through their respective sampling periods. Slowed demand for housing was clearly seen through the Building Permits report, with a well-publicized real estate slowdown likely having its effects on Business Confidence. Yet inflation hawks cite an exceedingly tight labor market and rising food costs as significant risks to domestic price pressures. New Zealand dollar bulls hope that such inflationary pressures will lead to hawkish rhetoric from the domestic central bank, with a highly-anticipated RBNZ rate announcement to highlight event risk in the week ahead.

The Reserve Bank of New Zealand is very widely expected to leave rates unchanged at its December 5 meeting, but forecasts subsequently show risks of potential interest rate hikes through early 2008. Very low unemployment levels have placed clear upward pressure on domestic wages, while strong foreign demand for New Zealand’s agricultural commodities leave rising food costs as a significant risk to price stability. Whether or not RBNZ Governor Alan Bollard hints at future interest rate increases will likely determine the short-term direction of the New Zealand dollar, with any disappointments in this regard likely to sink the Kiwi against similarly high-yielding counterparts. Otherwise, it will be very important to watch general risk sentiment as it relates to the performance of global equity markets. As we have seen through the past several weeks of trading, the New Zealand Dollar is especially sensitive to volatility in the US Dow Jones Industrial Average and Japanese Nikkei 225. Subsequent outlook for the currency will depend on forecasts for stock market gains.

Boris Schlossberg is a Senior Currency Strategist at FXCM.