Dollar – Back From The Brink
It could have been a lot worse. A 50bp cut from the Fed. A negative 17,000 NFP against expectations of 70,000 new jobs and yet the dollar held its own refusing to give way to the key 1.5000 level against the euro. The NFP and the GDP news earlier in the week were absolutely horrible clearly indicating that the US economy has ground to a halt and in turn practically ensuring that the Fed will have to cut rates another 50bp in March. Yet for all the negative fundamentals the dollar ended the week only 150 points lower against the euro. Part of the reason for greenback’s strength was technical in nature. Currency traders aren’t worried only about the US economy but the UK economy as well, which has led many to sell cable along with the greenback. The weakness in cable on Friday, eventually pulled down the euro and once EUR/USD could not hold the 1.4900 level, profit taking kicked in and the pair collapsed for rest of the day.

Nevertheless, the long term prognosis for the buck is dour. The economic standstill suggests that the Fed will have to continue easing rates for at very minimum through the first half of 2008 and as the interest rate differential expands further into euro’s favor the pair is likely to make another run at the 1.5000 level.

The one ray of sunshine on the US economic calendar was the better performance in exports which helped pull the ISM Manufacturing above the 50 boom/bust level. The news may help boost the reading for Factory Orders and ISM services this week which could help the dollar recovery, but if the data misses to the downside, the last of the dollar bulls may throw in the towel and the greenback could be headed to all-time lows.

Euro – No Cut in Sight
The single biggest obstacle to further upward progress by the euro has been the concern of many market players that its interest rate advantage over the dollar will not last. The proponents of the recoupling theory claim that EZ economy will soon feel the pain of US slowdown and ECB will have to follow the Fed and lower rates. So fa,r however, nothing of this sort is happening. The EZ economy continues to chug along at an unspectacular but steady pace with PMI Manufacturing gauges remaining comfortably above the 50 boom/bust level. While consumer demand and sentiment, especially in Germany, remains tepid at best, labor condition continue to improve and as we noted on Thursday, “For the time being the improving labor markets allow Mr. Trichet and company to remain unapologetically hawkish, but should employment begin to slow or worse contract, the pressure on the ECB to ease will become enormous.”

Next week, the EZ economic calendar is quite light with only EZ Retail Sales on the docket. The number is likely to show improvement despite the woeful showing from Germany, as French sales improved substantially last month. They key event risk for the week however will be the ECB rate announcement on Thursday. The market expects no change in policy, but as always will be listening carefully to Mr. Trichet’s post announcement remarks. The ECB chief has been consistently hawkish and there is little reason to think he will change his rhetoric. However, should he sound a note of caution or perhaps suggest that EZ economy is slowing, the pullback in euro could become much more severe as markets will interpret those remarks as a possible preparation for ECB easing.

A Recovery in Carry Trades May Lift USD/JPY this Week
The Japanese yen traded choppily across the majors last week as the markets were thrown into turmoil amidst volatility in equities. Indeed, the Federal Reserve's 50bp rate cut came as no surprise, and stock markets in the US ended the week on a positive note as the Dow managed to break above several important resistance levels. However, the resilience of this more positive sentiment is questionable, as pessimism may ebb and flow with the continuous deterioration of US economic data. Likewise, economic reports out of Japan have reflected slowing as well, but as we've witnessed over the past few months, Japanese news has had little bearing on Japanese yen trade.

That said, with risk aversion trends and the status of the US dollar remaining the primary driver of USD/JPY – rather than Japanese fundamentals – price action in global stock markets remain the key event risk for the pair. If flight-to-safety emerges again, the Japanese yen pairs may start to spiral lower. However, we are more likely to see that carry trades will stabilize in the near-term, which may translate into a recovery of USD/JPY above 107.92. From a fundamental perspective, expected declines in Machine Tool Orders and in the Eco Watchers survey would contribute to such a move higher, but as we've said, Japanese economic news does not tend to move this pair very much.

With the BoE Expected to Cut, the Pound Downtrend May Reengage
A two-week rebound for the GBP/USD ended spectacularly last Friday when the sterling plummeted nearly 300 points from its intraday highs. This massive move began just before the open of the US session, but really caught fire after the US data crossed the wires. Oddly enough the pair’s dollar-rally was triggered by the worst US employment report in four years. However, as proof that the GBP/USD’s drop wasn’t merely the fundamental confusion of the US data, there was clear unloading of the pound across the currency market: EUR/GBP broke through 0.7500 resistance on a 50-point rally; GBP/JPY slipped 200 points to extend its steady downtrend; GBP/CHF dropped 250 points before retracing half the loss; and GBP/AUD careened over 450 points.

While there was no specific, scheduled event risk to trigger the cascade in the pound, the pressure for a selloff was building up all last week. The week opened on a poor footing when the CBI issued its retail sales report for January. The proprietary indicator was halved from the previous month with sales falling to their lowest level in 14 months. Readings on the consumer sector didn’t improve much from day one. The GfK consumer confidence survey for last month unexpectedly rebounded; but this modest improvement was hardly something to cheer about when overall sentiment is just slightly off 12-year lows. Perhaps more concern for Brits were credit conditions. Lending for personal loans dropped to there lowest level in 15 years in December while mortgage approvals dropped to their lowest level since records began back in 1999. With consumer debt still near record highs and credit conditions faltering quickly, the outlook for domestic spending and growth are becoming bleak indeed.

In the week ahead, fundamental event risk will slowly build up into the market defining BoE rate decision. In the first few days of the week, the market will cover a number of second-tier reports that promise little in the way of market movement. January activity reports for construction and service sector activity are expected to cool along with manufacturing, a leading sign of a slow down in general growth. Speaking of growth, the leading indicators index for December will offer a forecast on expansion for the following three to six months. On the next rung up in market potential: the HBOS Plc house prices index will offer another (probably bad) look at the struggling residential market; the Nationwide consumer sentiment gauge will contrast the GfK report; and the government’s manufacturing report will be bounced off of last week’s factory PMI. Finally, on Thursday, the BoE rate decision will likely act as the top market mover for the entire FX market. The MPC is expected to cut for a second time since halting its appetite for quarter point hikes. Lowering the overnight lending rate to 5.25 percent would clearly erode the pound’s yield advantage; but more importantly, it will offer evidence that the central bank is worried about growth. A second rate cut would almost certainly encourage comparisons between the UK now and the US before it started on its path towards a possible recession.

Swiss Franc Reaches Post-Bretton Woods Record High
The Swiss Franc continued to set modern era highs against its US namesake, as continued dollar weakness and strong CHF demand sunk the USD/CHF to a fresh post-Bretton Woods low. Sharply disappointing Swiss KOF Leading Indicator results were not enough to restrain the continued Swissie advance, while a later positive SVME Purchasing Managers Index result had little effect on the domestic currency. Yet the Franc did in fact respond to a Friday morning US Non Farm Payrolls report, surging in the moments that followed the dismal American labor market data. A subsequent dollar reversal left the USD/CHF significantly higher through Friday trade, and one has to wonder whether the currency pair has set a short-term low at the intraday trough of â‚£1.0730. The risk-sensitive currency gave back much of its earlier-week gains on a significant recovery in global risk sentiment. Indeed, the US Dow Jones Industrial Average finished Friday trading at over 1000 points above its recent depths. Outlook for the Swiss currency will subsequently depend on whether or not the Dow may continue to recover from its recent selloff and significant Swiss economic event risk in the week ahead.

The Swiss economic calendar will be relatively empty through the first half of the week, but a key Unemployment Rate report on Thursday and Consumer Price Index data on Friday will easily compensate for the lack of event risk through end-of-week trade. Economists predict that the domestic Unemployment rate remained unchanged at a multi-year lows of 2.6 percent—a sign of robust job prospects in the landlocked European economy. Such a result would certainly prove bullish for economic outlook and, by extension, the domestic currency. A cursory look at Swiss money market yields shows that markets believe domestic interest rates will remain unchanged through 2008. Given a bearish outlook for yields in other major economies, the stable outlook has been a key source of Swiss Franc strength. Yet such an important source of Swiss Franc support could potentially shift on Friday’s Consumer Price Index report. Current consensus forecasts call for a sizeable 0.5 percent CPI decline through the month of January, but base effects will likely take the year-over-year rate to an above-target 2.2 percent. Any disappointments in the number could potentially shift forecasts on Swiss National Bank interest rate policy, sending the CHF lower in the process. Yet we would argue that an above-forecast CPI print is somewhat less likely to boost SNB rate expectations, and risks arguably remain to the downside for the CHF ahead of the report. Given strongly overbought conditions in the Swiss Franc, any disappointments in CPI or Unemployment numbers could force noteworthy retracements.

Canadian Dollar Trend may be Defined by its Own NFPs
It seems USD/CAD can’t leave parity for long. The pair made another run on the psychological influential level last week – this time from above. Slipping below 1.00, the Canadian dollar proved it wasn’t going to simply give up the gains it had accumulated over the past few years. However, the move below this level didn’t guarantee momentum – to the chagrin of loonie bulls. Not far below parity, at 0.99, the downswing quickly ran out of steam just as Canadian fundamentals started to come into play and dollar-side bidding started to curb the move. With the pair holding 0.99, there is a clear rising trend channel beginning in mid-November; and traders will no doubt jostle between scheduled and exogenous event risk and these technical boundaries to decide the fate of the USD/CAD, medium-term uptrend.

Looking after the past week for fundamental influences, there were only a few notable indicators to guide price action within the constraints of the pair’s technical limits. Business conditions orders for the quarter through January printed an unexpected improvement on its headline reading that pulled the gauge off a one year low. However, the breakdown certainly took the bullish wind from the glossy headline number. Of the 3,000 business leaders surveyed by Statistics Canada, 33 percent projected a drop in activity, offering the worst outlook since 2002. This isn’t surprising considering the impact an expensive Canadian dollar and the quickly falling demand from the US is having on exports. The other notable indicator for the week was the November GDP report. The report sustained a trend of positive growth for a 14th consecutive month. On the other hand, the breakdown revealed the sectors that recorded improvement over November are the same ones that have presented with the greatest risk in more recent months. Credit market turmoil and stumbling consumer sentiment hadn’t fully impacted the housing market apparently as construction activity rose 0.1 percent. Even more interesting was a 0.2 percent increase in financial services just as stock market volatility began to pick up. On the other hand, both industrial production and manufacturing slipped 0.2 percent. The only promising component was retail sales, highlighting the economy’s dependency on the Canadian consumer.

In the week ahead, the economic activity will step up in both quantity and quality. The market is still looking for signs that the Canadian housing market will catch some of the US subprime bug. The December building permits and January housing starts readings will give the sector a check up. For the already struggling manufacturing sector, the Ivey PMI is expected to improve modestly – though not enough to put it into expansionary territory. With the Canadian dollar still hovering around parity, raw material costs rising and lending activity tightening, the room for improvement is limited. Finally, Canada’s own nonfarm payrolls report will top the list with an expected rebound in net employment. A 10,000 person increase in payrolls would be little consolation to the first contraction in 8 months in December. This will undoubtedly be a situation where the details could define price action.

RBA Rate Hike Looks Likely, But Will the Aussie Rally Continue?
The Australian dollar was one if the best performers in the forex markets last week, as the Federal Reserve's rate cut ensured US Dollar weakness. Apparently, relatively soft consumer confidence reports out of Australia did not play much of a role in AUD/USD trade, as the markets have set their focus on the Reserve Bank of Australia. Indeed, while most central banks are in the process of cutting rates or are considering doing so, the markets may see something unusual this week: a rate hike. However, given the broad macroeconomic picture, a 25 basis point rate increase by the Reserve Bank of Australia may not be incredibly shocking. Indeed, the upcoming releases of the Australian trade balance and the Q4 house price index may add to the mix, as mining shipments may help to narrow the trade deficit while prices in the housing sector are forecasted to have grown at the fastest pace in nearly 4 years. Furthermore, while retail sales are forecasted to slow, a 0.6% increase is nothing to scoff at. Meanwhile, the RBA's weighted-median index of inflation jumped 1.1% in Q4, pushing the annual rate of growth to a 16-year high of 3.8%. With CPI expected to hold above 3.0% during the first half of 2008 as well, it's no wonder the central bank holds such a hawkish bias.

In fact, in the policy statement from the RBA's December meeting, Governor Glenn Stevens noted that "recent information continues to indicate strength in demand and output in Australia, with the economy having relatively little surplus capacity." While the Board remained "concerned about the outlook for inflation," increased "uncertainty about the international outlook and the local trends in wholesale borrowing costs" left the RBA to judge that "the current stance of monetary policy should be maintained for the time being." Though the global outlook for growth remains uncertain and credit conditions have tightened somewhat domestically, they are no where near "crunch" conditions and as a result, the RBA may be more comfortable considering rate hikes. However, as we've seen following past rate hikes by the RBA, the Australian dollar tends to rally ahead of the expected decision, but subsequently falls lower in the aftermath. As a result, further upside for AUD/USD may be limited, and a pullback towards 0.8817 could be in the works.

New Zealand Dollar Rallies on Trade Balance Surprise
The New Zealand dollar finished the week significantly higher against its US namesake, climbing to fresh 7-month highs to finish Friday currency trading. Continued recovery in global risky asset classes undoubtedly played a part in the kiwi advance, while bullish Trade Balance numbers likewise boosted the attractiveness of the Asia-Pacific currency. The economy posted its first trade surplus in seven months through December, as a sharp gain in Exports combined with a noteworthy drop in Imports to produce an unexpected NZ$33 mil positive trade balance on the month. Indeed, Exports rose by an impressive 24.8 percent through 2007. Strong external demand for domestic agricultural production can only boost exports further through the medium term, and markets responded accordingly. Some analysts have gone as far to claim that robust demand for New Zealand dairy products will continue to drive strong price gains in the domestic economy—keeping the Reserve Bank of New Zealand on a neutral-to-hawkish bias on domestic price pressures. Money market yields suggest that traders predict that RBNZ may raise rates through 2008, and an expanding NZD/USD yield advantage could only further drive New Zealand dollar gains. Yet such outlook will likely depend on upcoming employment and wage figures, the likely highlight of short-term NZD/USD currency trading.

New Zealand employment data is likely to drive major NZD volatility through the coming days of trade, with any sharp surprises to easily shift sentiment on the state of domestic labor markets. Consensus forecasts show that many believe the Unemployment rate rose through the final quarter of 2007, as a slowing employment change rate falls behind increased labor market participation. Yet a noteworthy minority believes that labor market tightness will continue to suppress the domestic jobless rate, and subsequent Private Wages growth may likewise surprise to the topside. Such results would easily force further New Zealand dollar gains, while disappointments could just as quickly force noteworthy Kiwi retracements. Other noteworthy event risk will come from the neighboring Reserve bank of Australia’s interest rate decision on February 5. Given that the currencies remain highly correlated, any sharp AUD volatility may translate to similar moves in the New Zealand dollar.

Boris Schlossberg is a Senior Currency Strategist at FXCM.