Dollar Finds Some Reprieve on Risk Aversion Though Data Keeps the Pressure On
On a trade-weighted basis, the dollar closed the week at a fresh record low. However, against some of the currency’s more aggressive counterparts, the pang of doubt in risk trends helped to keep the greenback from much worse. US equity benchmarks experienced their worst selloff since February 5 after insurer and Dow component AIG reported a massive $15 billion writedown on trouble mortgage securities. This evidence that subprime losses have spread into more mainstream insurance in turn revived fears of a sustained credit crunch and temporarily saved the dollar from further losses in all its major pairings except the positive yielding USD/JPY and USD/CHF. If it weren’t for the inadvertent assistance from risk trends, the greenback would likely have succumbed to the session’s disappointing lot of scheduled economic data. The morning brought the end of the month spending numbers for January; and the readings did little to encourage a brighter outlook for the world’s largest economy. Personal income rose 0.3 percent last month to outpace expectations while still cooling from December. A false sense of bullishness from a stronger than expected 0.4 percent increase in spending was quickly snuffed out when the market realized the boost was primarily due to higher prices and not greater volume. Further complicating the issue, inflation reported by the PCE deflator accelerated to its fastest pace in over two years. Irrational fears of stagflation are looking less absurd. The rest of the session was reserved for the Chicago Purchasing Managers Index and final U. of Michigan consumer sentiment survey, both for February. The confidence gauge was revised slightly higher, though it was unable to shake 16-year lows. Equally concerning, the Chicago manufacturing report plunged to its lowest read in 5 years. Along with Empire, Philly and Richmond Fed indexes, this Chicago report promises a very week ISM reading on Monday. For the rest of the coming week, the fourth quarter mortgage delinquencies will asses the full damage in the lending market, but the market’s true interest will lie with the expected 25,000 rebound in February NFPs.

Euro Stable Around 1.52, ECB Rate Decision Looms
Though holding near its record highs against the US dollar and British pound, the euro closed its Friday session little changed from where it opened. The calendar submitted measures of both economic activity and inflation for ECB President Jean Claude Trichet and his fellow rate setters to consider at next week’s monetary policy meeting. Adding weight to ECB Member Weber’s comments earlier this week that those betting on an interest rate cut were underestimating inflation, the German and Euro Zone headline CPI numbers kept the hawkish pressure on. According to the German consumer inflation gauge, annual price growth held at 2.8 percent for a third consecutive month through February – just off of the recent record high set in November. The region wide report, on the other hand, was a little more interesting. Headline inflation met expectations of a modest acceleration to a record high 3.2 percent annualized rate. However, in stark contrast, the core price gauge unexpectedly slipped to its slowest pace in a year. This divergence between readings is a clear reflection of soaring food and energy prices and the lack of notable pressures in most other groups. Consumer spending, the backbone of growth, was also a mixed bag. A 1.6 percent jump in German retail sales was the first increase in four months, though it was largely won on temporary promotions. Altogether today’s data did little to clear up the outlook for European monetary policy over the coming months.

Pound Marks New Record Low Against Euro as Housing Slump Deepens
The British pound was unable to capitalize on the dollar’s weakness over the past few sessions; and today’s data reminds us why: the UK economy is looking a lot like its US counterpart a year ago. An unfolding housing recession is perhaps the most blatant comparison being made between the two economies. The Nationwide House Prices indicator for February reported the fourth consecutive monthly decline in residential inflation – the worst trend from this series since the beginning of this decade. What’s more, the annual gauge cooled more quickly than expected for its worst reading since September of 2005. The sticky credit market is another factor that may cool the UK economy to a crawl. Banks have yet to pass on the BoE’s recent rate cuts, leading to the second fewest mortgage filings on record.

Comm Block’s Rally Falters, Central Banks Take Center Stage
After an impressive bullish run from the com block, there was finally a break in the rally at the week’s end as risk aversion led traders to ease off the high risk, high yield currencies. The docket was limited to the fourth quarter Canadian current account which printed slightly worse than expected with the gauge’s first deficit in nine years. The fundamental docket is fully loaded next for all three currencies. The RBNZ rate decision will top New Zealand risk. The Aussie dollar is ready to accept another RBA rate hike, as well as a retail sales, quarterly current account and fourth quarter GDP reports. Finally, the Canadian docket is loaded with the greatest risk as the Ivey PMI, fourth quarter growth and employment numbers will join an expected BoC rate cut due Tuesday.

Yen and Franc Surge on Traders’ Flight from Risk
With the credit market freezing up on the news of AIG’s massive writedown and the lack of progress in reaching a deal for rescuing bond insurer Ambac, the funding currencies of the carry trade were fueled for yet another astronomical rally. The yen rallied to a three-year high against the dollar with a three-day move that has totaled nearly 350 points. The franc has done even better in four days with 480 points and a record high just short of 1.04 against the greenback. The number of rate decisions next week should have an interesting impact on risk.

Kathy Lien is the Chief Currency Strategist at FXCM.