Dollar – Close To Pessimistic Extreme?
The one-way price action in the EUR/USD continued unabated this week, as the pair sliced through the 1.5200, 1.5300 and 1.5400 figures. However, even Friday’s worse-than-expected NFP numbers could not bump it over the 1.5500 hurdle. Non-Farm payrolls were as ugly as many analysts thought they would be with the private sector losing more than 100K jobs. The unemployment rate declined to 4.8% from 5.0% expected, but it was Pyrrhic victory as the number reflected the fact that many workers gave up looking for a job rather than any tightening of labor conditions.

With NFP registering its second consecutive month of job losses, the US economy edged closer to a recession with the news nearly guaranteeing at least a 50bp point cut by the Fed. In fact the markets are now factoring more than 80% chance of 75bp cut from the Fed. Yet despite the incessant torrent of bad news the EUR/USD actually sold off in the classic ‘buy the rumor, sell the news” dynamic. After climbing in a near uninterrupted fashion from 1.4700, the pair was due for a pause as euro longs booked massive profits. The retrace in the EUR/USD, however, is likely to be relatively shallow as the 1.500o level which acted as such serious resistance for several months, will now most likely act as support. On the economic front there is little to help the dollar. The two key events next week, Trade Balance and Retail Sales, are unlikely to provide much hope for dollar bulls. The Trade Balance deficit is expected to expand once as the cost of higher oil imports will offset any gains in exports. Retail Sales, too can disappoint given this week’s bleak employment picture. In short, while the dollar remains grossly oversold, there appears to nothing on the horizon to turn trader sentiment just yet.

Euro – Trichet Stays Tough
We wrote on Thursday that, “The one-way price action in the EUR/USD is clearly a concern for European finance officials. Yesterday, Jean-Claude Junker noted that growth in the region was slowing and the exchange rates do not reflect fundamentals adding that, “In the present circumstances that we face we are concerned about excessive exchange rate moves.”

It will be interesting to see if Mr. Juncker’s comments will be echoed by today by ECB chief Jean Claude Trichet, who up to this moment has steadfastly refused to make any judgments regarding the lofty value of the currency. If Mr. Trichet acknowledges the slowdown risks in the EZ economy and further hints at the possibility of a change in policy sometime in the near future, the EURUSD could see some long overdue profit taking. On the other hand if Mr. Trichet brushes off any concerns regarding exchange rates moves (the eurp not only hit a high against the dollar, but against the pound as well) he will in a sense flash an “All Go” sign to momentum traders willing to test the 1.5500 level in the next several sessions”

The euro came within 40 points of the 1.5500 level after the horrid US NFPs, but profit-taking drove the pair down to 1.5350 by the end of the week. Still, the week ahead looks relatively positive for the euro with Industrial Production, German Trade Balance and ZEW all expected to perform well. The EUR/USD may see further profit-taking in the days ahead, but the moves are likely to be shallow as the fundamentals continue to signal that EZ interest rates will not be lowered any time soon.

Yen To 100?
After coming close several times during the night, USD/JPY finally traded below 102.00 on Friday, the first time it has done so in more than 3 years. Can it get to 100? Japanese officials remained muted in their comments about the latest bout of yen strength, with Finance Minister Nukaga only noting that policymakers were closely watching the FX markets without mentioning any specific levels. Still, Tokyo fiscal officials cannot be comfortable with the idea of USD/JPY at 100 or worse below it. Exporters continue be the lifeblood of the Japanese economy and the current dynamic of unfavorable exchange rates and slowing global demand is sure to put a squeeze on their profits from both sides.

The question, however, is whether the BOJ will be able intervene effectively to stop the greenback’s slide against the yen. With Japan hosting the G-7 this year many analysts feel that the BOJ’s hands are tied diplomatically. Furthermore, it is not at all clear that intervention may work this time. The massive speculative unwind of the carry trade continues and given those flows the BOJ would have to spend an enormous amount of capital to stem the tide. Last time the BOJ expended nearly 250 Billion dollars to arrest the decline of the dollar. That trade actually became enormously profitable for the Japanese when the Fed began raising rates in 2005. This time however, the US monetary policy continues to call for further rate cuts. Whether Japanese officials will have the political will power to expend enormous amounts of capital on what may turn out to be a losing cause, remains to be seen. In the meantime the unit continues to draw strength from risk aversion as the DJIA loses value by the day. With Dow now below 12,000 any further weakness could bring USD/JPY 100 could be put in play as early as next week.

The calendar next week provides little support to the yen with exception of the Eco Watchers survey which may finally rebound off its lows after Labor Cash earnings improved last month. Still yen has long ago stopped trading on fundamentals and if equity flows continue to be negative this week, the 100 barrier may be breached.

British Pound Rallies Above 2.00 as Inflation Prevents BOE Rate Cut
The British pound rally continued last week as the Bank of England’s decision to leave rates steady at 5.25 percent suggested that the Monetary Policy Committee is more concerned about the threat of inflation than the downside risks to growth. Indeed, while credit conditions in the UK remain extremely tight and an economic slowdown appears to be taking place, the fact that commodities such as oil continue to ascend to record highs indicate that price pressures are building steadily. Though the US Federal Reserve has brushed these factors off, the BOE is paying heed which has worked greatly in favor of GBP/USD bulls. However, it is worth noting that while the forex markets may be focused on the Bank’s slightly hawkish bias, traders may take note of BOE doves like David Blanchflower on March 19, when the minutes of the March 6 MPC meeting will be released, as there was likely at least one vote for a 25bp rate cut and commentary indicating that an April rate cut may be looming on the horizon.

This week, the Cable bulls may continue to reign if they can push the pair above substantial resistance at the 2.02 level. According to a Bloomberg News poll of economists, the consensus reflects expectations for a 1.6 percent gain in producer input costs and a 0.6 percent rise in producer output prices. Such readings would not only suggests that broad inflation pressures are mounting, but also that companies are feeling the squeeze on their profit margins as they are unable to pass through the increased costs to their customers. The news will set the stage for the release of CPI the following week, which may show that consumer price growth accelerated faster than the BOE’s 2.0 percent target once again, but with the downside risks to the economy still of major concern to the MPC, it may not prevent the central bank from cutting rates again in the near-term.

Swissie Surges as Inflation, GDP Growth Accelerates
Similar to the Japanese yen, the low-yielding Swiss franc surged last week as lingering risk aversion weighed on carry trades. Meanwhile, February's CPI reading revealed inflation stayed at the 14-year high it reached last month, accelerating 2.4 percent from a year ago driven by buoyant commodity prices. The SNB left rates unchanged on December 13, expecting an easing in inflationary pressure as global growth decelerates with a recession in the US. The exchange rate has also offered some relief, as the increased purchasing power from the rallying franc has helped shield import-dependent Swiss consumers from ballooning prices abroad. Meanwhile, fourth quarter GDP unexpectedly jumped 1 percent, the fastest pace in more than two years, as business and consumer spending fueled expansion.

That said, the SNB is expected to keep rates on hold again when they meet this week. Like the European Central Bank, the significant downside risks growth and jittery financial market conditions will prevent the SNB from raising interest rates. At the same time, mounting inflation pressures will likely keep the SNB from cutting rates. Nevertheless, with support holding below at the 1.02 level for the USD/CHF pair, there is limited potential for the Swiss franc to gain further.

USD/CAD Could Jump Above Parity this Week
The Bank of Canada unexpectedly slashed rates by 50bps to 3.50 percent - the sharpest cut since 2001 - as the bank saw some downside risks to the Canadian economy "intensifying" as "the deterioration in economic and financial conditions in the United States can be expected to have significant spillover effects on the global economy." While the Bank said that domestic demand has remained buoyant on the back of rising commodity prices and high employment, they also noted that they now judge that "the balance of risks around its January projection for inflation has clearly shifted to the downside." Furthermore, the Bank left the door open for additional rate cuts in the future, as they said that "further monetary stimulus is likely to be required in the near term." Nevertheless, the Canadian dollar ended last week little changed as Canadian business conditions proved to be surprisingly resilient in February given the surge in Ivey PMI to an 8-month high of 62.0 from 56.2. This was the second consecutive month of improvement after the index plummeted below the critical 50 level in December, signaling contraction. Furthermore, the net employment change beat expectations hand over fist, as the economy added 43,300 workers in February against forecasts for a mild gain of 3,000.

Looking ahead to this week, USD/CAD could stand to gain as housing starts are forecasted to slow while the trade balance is anticipated to show only a mild improvement. However, the status of the US dollar and oil prices may be the biggest determinant of the pair’s next move. Both the decline of the greenback and the rapid rally in oil may be a bit overextended at this juncture, and if the markets see even the slightest correction this week, the price action could push USD/CAD above parity once again.

Despite Rate Hike, a Dovish RBA Dampens Bullish Sentiment
The Australian Central Bank raised their benchmark interest rate a quarter point to a 12-year high of 7.25% as expected. The second hike in four weeks was anticipated to push the Australian dollar towards the 24 year high it set on February 28. However, Dovish commentary from the RBA signaled that their efforts to reign in the their 17 year run of economic growth was coming to an end. This lead to a week of choppy price action based on record commodity prices, deteriorating fundamental data and increased risk aversion. Carry trade unwinding led to the Aussie selling off against the yen and Swiss franc and becoming one of the worst performers against the dollar on the week. Despite this, recent anti-dollar sentiment saw the pair steadily climb from 0.9250 to 0.9737 , before a negative U.S. Non Farm Payroll number thwarted the rally.

Central Bank Assistant Governor Malcolm Edey derailed any hopes of an Aussie rally when he cautioned, “there are significant dampening forces at work”. Intimating that higher interest rates, tighter lending standards, and a strong local currency will slow economic expansion and reduce the need for future interest rate hikes. The pair saw further selling when the Australian trade balance reported a greater than expected deficit and building approvals disappointed. As a strong currency fuels an appetite for imports, exports are being weighed down by infrastructure bottlenecks and slowing global demand, resulting in a net outflow of Australian dollars, ultimately putting pressure on the currency.

The Australian consumer will be on center stage next week, as employment and consumer confidence is on tap. Rising inflation, record energy costs and tighter credit costs are expected to weigh on the labor market and sap consumer confidence. Any evidence to the slowing of the economy will continue to pressure the Aussie. Additionally, traders appetite for risk will remain an underlying influence on the pair as the affects of the U.S. slowdown and subprime crisis are measured. It appears that price action is consolidating and we may see it continue to move sideways, trading in the 0.9250 -0.9400 range. Despite, the signs of a slowdown, the Australian economy is still one of the strongest in the world and its high yielding currency will remain an attractive place for investors, which still leaves significant upside potential.

Risk Aversion Continues Downward Pressure on Kiwi
As the prevailing risk aversion sentiment lingers throughout the markets, pressure mounts on the New Zealand dollar. The steady unwind of carry trades has seen the high yielding currency decline almost 300 points from its multi-decade high of 0.8213. After testing the 20-Day SMA four days in a row, the pair finally closed below the support level on Thursday after the RBNZ left rates unchanged. The recent negative U.S. NFP print will feed investors fears of a U.S. recession and continue to put pressure on the “Kiwi”, weighing it down to the 0.7900 support level of the 38.2% Fibo level of 0.7983- 0.8213.

The only event risk that was on the week’s calendar was the RBNZ’s official cash rate announcement. As expected the MPC left rates unchanged at 8.25%, keeping it the highest yielding major currency. The central bank in its statement acknowledged that downside risks are increasing as inflation, and a strong currency are weighing on exports. Additionally, RBNZ Governor Alan Bollard acknowledged that the tight credit markets are unwinding the carry trade, but he believes “ It is not yet evident the carry trade is dead”, which may mean that the remains upside potential for the “Kiwi”.

Next week’s economic docket brings significant event risk for the pair, as Business PMI, Retail Sales and Manufacturing Activity will be announced. Retails sales, coming off of last weeks decline, may see further deterioration as consumer spending is being crimped by rising fuel and food costs. If the manufacturing sector shows weakness in addition to slowing consumer spending, traders will start to price in the possibility of a future rate cut and put downward pressure on the pair. However, stronger-than-expected retail sales may see the “Kiwi” rally, especially if it drifts down toward the technical support level of 0.7850, the 50-Day SMA.

Boris Schlossberg is a Senior Currency Strategist at FXCM.