Dollar – Rebound Into the New Year?
A funny thing happened on the way to a US recession – it never materialized. The currency market which has been dominated by doom and gloom visions of contracting US consumption as housing values dwindled by the day, was shocked to find out that the US consumer was alive and well in November as Retail Sales report printed at nearly twice the pace of the forecast. Sales advanced 1.2% vs. 0.6% projected and although a large portion of the gain was due to increases at the gasoline pump, the overall data indicated that the US consumer has not tightened his purse strings just yet.

As we wrote in Friday, ‘We’ve long argued that the US consumer is far more affected by labor market demand and wage growth rather than asset deflation and as such was less likely to curb spending significantly given the relatively healthy employment background. Yesterday’s Retail Sales produced the right catalyst for a greenback rally which has been woefully oversold and today’s price action, given the lack of overnight economic news suggests profit taking from some long term accounts and massive liquidation from late euro longs are the primary drivers of the move.”

With only a few weeks left in the year, the need to lock in profits could persist next week and provide dollar with an added boost as more EUR/USD longs are unwound. There are some spots on the calendar however, that could give dollar bulls some pause. The front of the week will be dominated by the TICS data which has been woefully short of expectations for the past few months running. The markets anticipate $45 billion – still short of the $60 billion needed to offset the trade deficit, but close enough that it would be viewed as dollar-positive were it to match expectations. The end of the week brings personal income and personal spending, and both are forecast to rise sharply form the month prior. If those numbers meet or beat expectations the greenback may have more room to go.

Euro Runs into Profit Taking
Aside from the typically dour ZEW survey which hit 14-year lows there was nothing particularly weak in EZ economic performance this week. However, having risen so far so fast, the unit was vulnerable to a bout of profit taking and with little on the calendar to convince traders that the next rate hike was imminent, most took the path of least resistance and booked their profits.

As we noted on Tuesday, “The EUR/USD will have hard time making it much beyond (1.4800) level, given today’s dour ZEW readings. Despite President Trichet hawkish posture at last week’s ECB press conference, the European monetary officials will find it inordinately difficult to tighten monetary policy further given the downcast investor sentiment expressed by the ZEW.” In fact by the end of the week, the pair broke below the key 1.4500 level and found itself only a few pips away from 1.4400.

Next week the EZ economic calendar is generally uneventful with only the PMI composite figures of some interest to the market. The region continues to perform well despite the dual obstacles of higher currency and higher energy costs, but a dip close to the 50 boom/bust line would send shivers through the currency market and could push the unit even further down. Nevertheless, economic data is unlikely to have much impact on trade next week as seasonal factors are much more likely to drive direction with many more participants looking to lock in profits for the year.

Yen Gives way to Dollar Strength, Japanese Data Disappoints
The Japanese yen fell against the US dollar for the third consecutive trading week, as overwhelming greenback strength offset otherwise poor form for global risky asset classes. The US Dow Jones Industrial Average actually rose to fresh monthly highs to start the trading week, but a significant deterioration in risk sentiment left the index a significant 440 points off of peaks through the weekly close. Momentum and risks subsequently remain to the downside for the sentiment barometer, but the Japanese yen could nonetheless continue to decline on a year-end position unwind. According to the Commodities and Futures Trading Commission’s COT data, net non-commercial Yen longs reached 3-year highs in the week ending December 4. Speculative long positions subsequently fell by nearly seven percent through December 11, and a further pullback could force continued USD/JPY rallies.

A disappointing week of economic data only worsened outlook for Japanese expansion, with domestic consumer confidence falling to four-year lows and key Tankan industrial printing notably below consensus forecasts. The former showed consumer’s willingness to buy durable goods at its worst level since 1997. Employment-linked survey readings were similarly anemic, as the Employment index dipped to 3-year depths of 43.1. A continued deterioration in consumer sentiment bodes very poorly for domestic spending, and producers will have to hope for buoyant international demand to keep output in positive territory. Subsequent Tankan Large Manufacturing data was far from reassuring, however, with the headline index falling below consensus forecasts at two-year lows through the fourth quarter. Central bank watchers now claim that the Bank of Japan may have a difficult time raising interest rates through 2008, but global risk sentiment may be far more significant for the yen than outlook for domestic interest rates.

The coming week will see relatively little in the way of significant event risk, and trading may become choppy as forex market liquidity dries ahead of year-end holidays. Indeed, the yen may see relatively directionless trade on a mix of underperforming equity markets and overextended JPY-long positioning. According to our Technical Analyst Jamie Saettele, however, it may see short-term upside against the British pound before significant tumbles.

Cable Tests 18-Month-Old Trendline, Big Decision at Hand
The British pound is standing at a technical cross roads. Last week, despite a slew of positive fundamental indicators, the sterling reversed a strong, early push higher against the US dollar to end down 140 points from where it started and 400 points from its Wednesday peak. Now GBP/USD is positioned just above 2.01, a level which may prove the turning point for a major trend change. Not only is the trend-friendly, 200-day simple moving average lingering just below last Friday’s lows; but a rising trendline, that has held up swing lows since June 29, 2006, falls right across the psychologically significant number. With the holiday fast approaching, the sterling could define the leg of a new, major trend before liquidity drains and those left in the market enter the no man’s land of volatility.

Certainly, last week’s data will make that decision a little more difficult. The front loaded calendar was painted almost entirely in green. The fundamentals started to pick up almost immediately on Monday with inflation, housing and growth numbers crossing the ticker. The Leading Indicators composite - used to forecast growth for the coming three to six months - for October backed bulls by marking the first improvement in four months and breaking a the worst trend in nearly two years. Far more market-moving was the PPI data. The BoE didn’t have the ONS statistics on factory-level inflation when it decided to cut rates the week before. If they had, the fastest pace of pass through inflation since 1991 may have kept the MPC on the sidelines, at least for a few more months. The visible trade report for October released the following day was less impressive though it was able to rebound from a record deficit to a 7.115 billion pound shortfall. The last round of positive data came with Wednesday’s labour data. An 11,100 drop in jobless claims in November brought filings to 813,000, the lowest level since 1975. At the same time, the claimant count rate ticked down to match a 32-year low and the ILO jobless figure marked a 13 month low. Fundamentally, everything was going in the pound’s favor until Friday when traders were reminded of the burgeoning housing slump. The RICS house price balance for November added to the myriad of disappointing records by marking its worst reading since May of 2005.

Looking at the docket for the week ahead, it’s clear that the holiday lulls aren’t upon us quite yet. Accenting the remarkable technical setup in GPB/USD the market will absorb a number of economic indicators that will add to the push and pull behind the pound. The leading Rightmove Housing Prices Indicator for December will show whether the UK property market is heading in a similar direction as its US equivalent or if it is merely a much needed, but temporary pullback. Tuesday, consumer-level inflation indicators will reveal whether the PPI output numbers have fallen squarely on the consumers’ shoulders. Expectations are modest, but a sharp increase could define rate speculation going forward. Speaking of the rates, the BoE releases the minutes of its last report on Wednesday, though the statement following the decision was likely a good summary. Lending data is covered Thursday, measuring credit market health and consumer spending at the same time; though, November retail sales will be more accurate reading of the latter market concern.

Swiss Franc Tumbles on SNB Decision, Rate Forecasts
The Swiss franc saw significant losses against major currency trading counterparts, as a disappointing Swiss National Bank interest rate announcement encouraged traders to sell the previously overbought currency. The highly-anticipated SNB meeting was the major highlight of recent currency trading, and CHF bulls were dismayed to hear a surprisingly neutral tone from central bankers on the future of domestic inflation and growth trends. The Swiss National Bank delivered unchanged 3M LIBOR rate target of 2.75%, as had widely been expected, but the attached statement showed little hope for future interest rate hikes from the monetary policy authority. Officials said, “Assuming that the three-month LIBOR remains unchanged at 2.75%, the [SNB] expects an average annual inflation rate of … 1.7% in 2008 and 1.5% in 2009.” Given that these forecasts are comfortably below the bank’s inflation target of 2.0%, one may assume that officials show little willingness to tighten policy further through the medium term. Such developments clearly hurt outlook for the domestic currency; the CHF had risen on expectations that the SNB would remain on its 2-year tightening cycle through the foreseeable future.

A significant tumble in the Dow Jones Industrial Average and other risk-sensitive asset classes failed to boost the Swissie, and momentum clearly remains to the downside through short-term trading. The coming week in economic event risk could potentially force directional volatility, however, with key production and consumption figures to dominate the Swiss calendar. First on the ledger will be quarterly Industrial Production figures at 08:15 on the 17th, while the following day’s Adjusted Retail Sales report could potentially force shifts in CHF sentiment on any sizeable surprises. Neither event has been known to force especially pronounced volatility for the Swissie, but the recent focus on SNB monetary policy may bring renewed importance to the reports. Thursday’s Producer & Import Prices data may have slightly less market-moving potential, however, as Swiss National Bank comments have downplayed the significance of upcoming inflation results. The bank fully expects that price pressures will increase through the first half of 2008, and markets will likely ignore anything but the most surprising results.

Parity Moves Further AwayfFor the Canadian Dollar
The Canadian dollar’s six-week decline seems to be as consistent as its unprecedented rise. Last week, the currency plodded through another choppy slide against its US counter part as mixed data and a volatile commodities market failed to produce a foothold in a sentiment driven market. Since the Bank of Canada became the second major Central bank to loosen its lending rates, die-hard bulls have grown more aware of the fundamental cracks in the currencies strength.

From the calendar last week, many of the docket’s notable reports were beating expectations; though most of these improvements came in among larger, worsening trends. The housing market has garnered greater attention as credit market problems persist and a cooling in the commodity-based employment boom has revealed the uneven growth in the country’s property markets. Construction activity grew faster than expected to a 227,900-unit annual pace through November, while the previous month’s figure was revised 8,100 units higher. However, neither of these changes truly makes up for the big correction from September’s three decade high – the sharpest percentage drop in housing starts since 1983. Hitting the wires a few days later, the New Housing Price Index for October was the only truly disappointing indicator for the week. A 0.1 percent increase in the average home price was fell short of the 0.3 percent inflation expected, and was subsequently the weakest pickup in ten months. Another common economic theme in the calendar was the health of the export sector. Factory shipments for October surprised traders with the second increase in six months. However, the 0.1 percent pick up was modest and a drop in inventory, unfilled and new orders components clearly eroded the value of the report. The key report for the week was the physical trade account balance for October. Despite the loonie’s appreciation to a record over that month and a drop in auto, industrial and energy exports, the surplus rebounded from its more than eight year low. A jump in machinery orders lifted the surplus to C$3.3 billion.

Looking at the economic listings for the rest of the year, all of the market-moving data has been consolidated to this week. Consumer-level inflation data will be an important angle for the Canadian currency after the BoC lowered the nation’s benchmark lending rate two weeks ago. November’s price pressure are forecasted to be little changed according to economists forecasts. A 2.4 percent headline reading is above the central bank’s target rate; yet underlying pressures are below the cap and expected to cool further to a 1.7 percent annual pace. A few other minor indicators aside, the simultaneous release of October GDP and retail sales will close the week with a fundamental bang on Friday. The economy is expected to grow a modest 0.1 percent, though the pull back in trade, consumer spending and weakening housing trends could weigh growth down. And, preparing for the retail sales report, we will use Wednesday’s wholesale sales report as a guide.

Aussie Likely to Be Weighed Down by Cooling Commodities
The Australian dollar tumbled over the course of the last week as commodity prices eased, while signs emerged that the labor market remains resilient and will continue to fuel economic growth in the country. Employment rose by a whopping 52,000 in November, which was more than double expectations for the figure. However, the unemployment rate actually rose to 4.5 percent from 4.3 percent. Why the divergence? With the labor markets continuing to tighten, unemployed people who were previously discouraged and stopped looking for work have come out of the woodwork to take advantage of the conditions, as the participation rate edged up to 65.3 percent from 65.0 percent. Meanwhile, an index of consumer confidence as measured by Westpac improved 1.8 percent in December, amidst stabilizing energy prices and signs that the Australian economy may be somewhat insulated from the subprime-related woes that are taking on toll on the US, Europe, and the UK. Indeed, the financial markets in those regions have proven so unstable that the US Fed, the ECB, the BOE, the BOC, and the SNB have made a coordinated effort to boost liquidity. The Australian markets, on the other hand, has seen little impairment in the "flow of credit to sound borrowers," according to the Reserve Bank of Australia's most recent monetary policy statement. With the commodity boom showing few signs of slowing, miners and other thriving Australian businesses will likely continue to aggressively hire works, which will raise inflation risks via wage and consumption growth.

Looking ahead to this week, there is little in the way of major event risk for the Australian dollar. Normally, the release of the RBA monetary policy meeting minutes would garner quite a bit of attention. However, the RBA's recent change in communication has already seen the issuance of a policy statement that indicated a fairly clear bias on the part of the central bank. While the minutes will give a more thorough view of the RBA's stance, there is no doubt that inflation remains a major concern and as a result, there is little chance that the minutes will change the market's view that the RBA remains hawkish. Nevertheless, additional declines in commodity prices could help weigh the Aussie down over the course of the week, especially as the US Dollar picks up strength.

New Zealand Q3 GDP May Be Hurt by Weak Exports
Similar to the Australian dollar, the New Zealand dollar has been weighed down by softer commodity prices, though the Kiwi also had to grapple with a plunge in consumer spending. Indeed, retail sales dropped for the first time in four months during October, as record high interest rates make an impact on the New Zealand economy. While cooling down the breakneck pace of growth in the housing sector, booming consumption, and upside inflation risks were clearly the main reasons for the RBNZ's monetary policy tightening cycle throughout the past year, the fact that consumption and housing prices have taken such a hit will help to allay speculation that the central bank will move to take rates higher one more time. Nevertheless, better-than-expected businesses PMI figures suggest that capital spending remains robust and will help to support the economy at large.

Looking ahead to this week, the current account deficit for the third quarter is anticipated to widen quite a bit, as the Kiwi's appreciation against the greenback earlier in the year was quite detrimental to exports. Furthermore, this may play a role in a slowdown in Q3 GDP, which is only forecasted to grow 0.4 percent from Q2. Though this figures are lagging indicators and do little to help gauge inflation risks – the primary concern of the RBNZ – the news could force NZD/USD lower over the course of the week as the markets will judge the interest rates in New Zealand are effectively on hold for the time being. Furthermore, if commodity prices continue to weaken, the New Zealand dollar could drop below 0.7600.

Boris Schlossberg is a Senior Currency Strategist at FXCM.