Can Dollar Bulls Jump Start a Rally?
As the week progressed it looked like the dollar counter trend rally may have finally arrived. Buoyed by better than expected ISM Manufacturing numbers and a surprisingly positive ADP estimate, dollar bulls were able to drive the EUR/USD to 1.5500 by mid-week. Most market players started to focus on the softening economic situation across the pond where data last week indicated that both EZ and UK are beginning to feel the impact of global slowdown in growth. As result euro started to lose its luster.

But as we noted on Friday, “Yesterday’s horrid US weekly jobless claims which printed above the key 400K level for the first time since hurricane Katrina completely changed the sentiment of the market.. Since the release of the jobless claims report at 12:30 GMT Thursday both euro and the pound have risen nearly 200 points on fears that US labor situation is deteriorating rapidly. With consumer debt at record highs, traders fear that a massive loss of jobs and income could send US reeling into a severe recession as consumers become unable to service their obligations and demand for goods and services contracts significantly.”

No doubt, the dour labor situation stopped the dollar rally cold, but with NFP’s now history, players may once again refocus on the economic troubles in the Eurozone. With US calendar containing only second tier data, the trade in the pair this week will likely be driven by event risk across the pond, most notably the ECB interest rate policy meeting next Thursday. While no one expects any change in policy, traders will be listening intently to any change in tone. If President Trichet sounds a more sober note regarding EZ growth and de-emphasizes the need to control price pressures, that may all that’s necessary to jump start the dollar rally once again.

ECB President Trichet Set to Make or Break the EUR/USD Rally
The EUR/USD pair ended the week slightly lower, as the overbought pair saw its rally lose momentum amidst a drop in Euro-zone retail sales. However, the more pressing issue for the Euro-zone economy is the hot inflation pressures in the region. Indeed, Inflation in the Euro-zone accelerated at a 3.5 percent pace in March from a year earlier, according to initial estimates issued by the EU's statistics office, marking the fastest pace in nearly 16 years. The data only underpins European Central Bank President Jean-Claude Trichet’s hawkish bias, as he struggles to maintain price stability while economic growth gradually deteriorates.

Nevertheless, the European Central Bank is widely expected to leave rates steady at 4.00 percent for the tenth consecutive meeting. The rate announcement will come at 7:45 EDT, but the big show is at 8:30 EDT when Trichet will give his monthly press conference. Will he remain hawkish, or focus more on the instability in the markets? There’s little doubt ‘price stability’ will be the foremost concern for Trichet given the surge in CPI in March, but there are other issues as well. The ECB has stepped in to inject liquidity into the money markets in an attempt to alleviate the tight credit conditions. As a result, if Trichet suggests that price pressures will moderate in the near-term or that feeble financial market conditions are threatening economic growth, the euro could actually sell-off across the majors next week.

Another BOJ Rate Decision on Tap
A combination of negative Japanese and positive U.S. fundamental data saw the USD/JPY make a steady ascend throughout the week, reaching above the 102 handle. The central bank’s Tankan survey fell to a four year low of 11, as a strong Yen and a slowing U.S. economy has started to weigh on corporate profits and confidence. Monday also saw the BoJ infuse a record $30 billion in liquidity into funding operations in order to stabilize the overnight rate, as the end of the quarter saw banks tighten purse strings. Stronger than expected U.S. manufacturing and service reports gave dollar bulls additional support as they took the pair from below 99.0 to a high of 102.70. A third straight decline in NFP’s sparked extreme volatility as risk aversion and dollar bearish sentiment took turns driving the pair.

Speculation has continued to increase that the BoJ may reduce their benchmark interest rate, as growth continues to slow. However, the lack of a governor has put the country in a precarious predicament. Monday’s actions demonstrated that the current state of the global credit markets and economy requires strong leadership from the central bank. The political stalemate has dragged on far longer than expected and has left Deputy Governor Masaaki Shirakawi effectively in charge. Although he remains the most likely candidate to replace outgoing Governor Fukui, the tepid demeanor of the University of Tokyo professor has given officials pause. The goal is to have a head in place before the upcoming G-7 meetings on April 11, in order to avoid humiliation. Expert expectations are that the MPC will leave rates unchanged at the upcoming policy meeting, however any comments that should follow will be closely scrutinized.

The economic docket will be full again this week with the leading economic index and eco watchers providing insights into the direction of the economy. If these forward looking indicators disappoint they may further weaken confidence and give support to dollar bulls. An expected decline in machine orders will on will evidence the pressures on manufacturers. A surprise in any of these gauges and expectations of a future Fed rate cut may weigh the pair back below parity, as the signs continue to point that the U.S. may be in a recession.

GBP/USD Downside Risks Prevail as BOE Expected to Cut
The British pound ended the week almost completely unchanged, as UK economic data proved to be quite mixed. Manufacturing PMI held steady at 51.3, while mortgage approvals fell less than expected to 73K from 74K. On the other hand, Services PMI and Housing Equity Withdrawals were both softer than forecasted. Aside from these economic releases, there is an overwhelmingly bearish cloud lingering over British pound: the UK housing sector. Unfortunately for the Bank of England, prospects for the sector are looking frighteningly similar to that of the US. On Friday, HBOS, the UK’s biggest mortgage lender, increased its minimum deposit to 5 percent from 3 percent, and said it would penalize borrowers that put up less than a 25 percent deposit on the property. Clearly, banks do not want to lend despite the BoE’s efforts to boost liquidity and cuts to the overnight lending rate to 5.25 percent. With global financial institutions seeking to reduce risk, a few rate cuts by various central banks is highly unlikely to convince them to lend aggressively once again.

Regardless, the BoE is widely anticipated to follow the lead of the Federal Reserve and reduce rates by 25bps to on Thursday. The rate decision will come at 7:00 EDT and will also include a monetary policy statement. Inflation pressures in the UK have not been quite as strong as in the Euro-zone, though CPI is still above the Monetary Policy Committee comfort zone. However, the credit crunch is taking a toll on the country’s financial and housing sector, as mortgage lenders start to raise rates in an effort to avoid taking on new loans. This has stoked concerns that the UK is in for a US-style housing market collapse, or worse, an all-out recession. As a result, the risks are tilted very much to the downside for the British pound.

Swiss Franc Slips as Cracks Show in Growth, Risk Eases
Through a relatively low volatile week for the majors, the USD/CHF actually ended last week 1.1 percent above its previous close. Surprisingly enough, the hearty price action through the period was generated not only from the cross currents from the US dollar and the general ebb and flow of risk appetite, but also from the Swiss docket. This is somewhat surprising considering the currency rarely reacts to its own economic data. Nonetheless, a three notable fundamental releases would ultimately drive the price action through profitable peaks and troughs. The first release to cross the wires was the March economic forecasts from the State Secretariat’s office on Monday. The outlook for growth is fading quickly with the government body forecasting expansion to cool from a 1.9 percent pace in 2008 to 1.5 percent through the first quarter of 2009. Household spending, capital expenditures, exports and inflation predictions follow a similar path. While this is a foreboding view of the economy, it really didn’t sway the franc. The SVME PMI for March, on the other hand, did. The business sentiment cooled much quicker than expected to its lowest level since August of 2005 as the demand for exports cools with the global slowdown in growth and the franc’s appreciation against the euro and US dollar. After the business sentiment report crossed the wires, USD/CHF rallied nearly 200 points. Friday’s inflation data helped to put the franc on a little more stable ground before the week closed. The consumer price index for March accelerated to a 2.6 percent annualized pace – its highest reading in over 14 years. With inflation now so far above the SNB’s target level, there seems more than enough fuel for a revival of the policy group’s quarterly rate hikes. However, considering this high was predominately reflective of record food and energy prices and the central bank expects inflation to average 2.0 percent this year, we will need to see whether the policy group will be unsettled by this data.

Over the coming week, the economic docket thins out and USD/CHF will most likely rely on US and Euro-Zone data and the franc’s correlation to broad risk trends for price action. The only indicator to cross the Swiss wires over the coming week is Monday’s unemployment gauge for March. The jobless rate is expected to tick lower to 2.6 percent last month, which would bring the indicator further off its highs for the past six months, but would keep it above the multi-year low 2.5 percent level seen only a few months ago. The ECB rate decision and policy statement will have offer guidance for the rate outlook back in Switzerland. Through the Swiss National Bank’s eight consecutive quarters of steady rate hikes through the end of 2007, the policy body followed ECB President Trichet’s steady cuts with about the same consistency. Outside of scheduled economic data, potential shifts in risk sentiment next week have the greatest potential influence over the franc. It is worth mentioning that over the past few weeks, the USD/JPY and USD/CHF correlation has broken down somewhat, while the latter has tightened its relation to the euro-based major. However, in the event of big shock to the financial markets, the franc will likely once again fall back into its risk track.

Canadian Dollar Finds Little Support from Data, Oil Still a Factor
The primary move from the Canadian dollar this past week was the currency’s steady, 300-point rally against its US counterpart following a shooting star reversal on Tuesday. At the beginning of the week, the economic calendar was attempting to influence the market with the first monthly growth reading of the year. Following the sharpest monthly drop in growth since August of 2003 with the December reading, the January number was set for a substantial rebound. Indeed, the forecast for a equally significant jump in expansion proved prophetic as the government recorded a 0.6 percent pickup that matched the largest positive change in nearly four years. Looking at the breakdown, every major component reported growth, though it was the manufacturing and wholesale sectors sharp reversals that were the heart of the advance. Ultimately, though, this data wouldn’t offer the Canadian much guidance. The same was true for the next round of economic releases hitting the wires on Friday. A heady mix of employment and business activity data would ultimately settle close to the market’s forecasts and encourage little market movement from surprised fundamental traders. The Ivey PMI unexpectedly contracted, but the 59.0 reading was still well above the contractionary/expansionary 50 level. The employment data was a little more interesting. The consistent forecast for a 15,000-person pick up in payrolls finally hit the market as employers recorded 14,600 new hires. This eroded the market impact the headline would have, but the details certainly gave market participants a reason to be concerned about the consumer’s future. The breakdown revealed full time jobs dropped by 19,600 and manufacturing positions continued to disappear thanks to fading demand for exports. This suggest consumers’ dependency on wages and employment are growing more concentrated on service based jobs and domestic consumption.

Over the days ahead, the economic calendar will have its influence on price action, but major moves will likely remain under wraps unless we see a major shift in one of the two themes in fundamental trends the data looks to follow. The most involved trend will look at housing as building permits and the new home price index for February and housing starts for March are all due. Expectations are mixed, but these indicators offer a broad gauge of health for the housing sector, which so far hasn’t suffered markedly from the global credit crunch, the previous BoC rate hikes or consumers downshift in spending. Nonetheless, any sign that the Canadian economy is catching the same flu that has infected the US, UK, New Zealand and Australian housing markets would certainly raise doubt. The other economic release and theme for the week is trade. Once again the outlook is calling for a modest change, despite very volatile changes over the past few months. Signs that surplus is destined for a deficit on currency and export demand concerns could send USD/CAD back to its recent highs. However, a genuine break to new highs will ultimately rely on oil. Should crude fall back below $100, there would be little justification for such an expensive currency with the outlook for domestic and foreign growth dimming.

Australian Dollar Outlook Takes a Hit on RBA Rate Forecasts
The Australian dollar finished the week modestly higher against its US namesake, as a noteworthy recovery in the US Dow Jones Industrial Average and Australian S&P ASX forced similar rallies in major high-yielding currencies. Yet fundamental outlook for the Australian currency took a fairly clear turn for the worse; dovish commentary from Reserve Bank of Australia officials suggested that domestic interest rates may have peaked in the current interest rate hiking cycle. The central bank announced that it left its target overnight interest rate unchanged at 7.25 percent through its most recent policy-setting meeting, and the attached text made a case for stable rate expectations through the medium term. Indeed, the bank said that the combination of previous interest rate increases and a deterioration in lending markets has made for “substantial” tightening of financial conditions to date. Such strong rhetoric on monetary conditions and a relatively muted outlook for domestic growth certainly suggests that the bank will leave policy unchanged through the foreseeable future. In fact, many claim that interest rates have now peaked and the RBA’s next move will more likely be a rate cut. All else remaining equal, this may remove a key pillar of fundamental support for the previously high-flying Australian dollar.

The coming week may certainly influence forecasts for outlook on domestic interest rates and growth, as key Trade Balance and Employment Change reports typically force major movements in relevant domestic asset classes. First on the ledger, economists believe that strong demand for Australian commodity exports improved the country’s international Trade Balance through the month of February—welcome relief following previously dismal trade deficit figures. The following Tuesday’s Employment Change data will likely be the highlight of the week, however, with any surprises to force commensurate move in the Australian dollar. Current consensus forecasts call for a modest 10,000 jobs gain through the period—representing the smallest gain since January of 2007. Yet we have previously seen Australian labor data trounce analyst expectations and continue to defy calls for slowdown. We will pay close attention to the results of said report, while general risk sentiment and the performance of global equity indices will likely drive general AUD volatility throughout short-term trading.

New Zealand Dollar Bid on Equity Rebound, But Outlook Remains Dim
The New Zealand dollar remained nearly unchanged against the US dollar through Friday’s close, as a recovery in global risky asset classes was not enough to leave the risk-sensitive NZD higher through the past week of trade. Disappointing economic developments limited demand for the New Zealand currency; both Building Permits and Business Confidence reports printed sharply worse than consensus forecasts and dimmed outlook for domestic economic growth. Building Permits fell 6.5 percent through February and now stand 17.9 percent lower on a year-over-year basis—underlining clear weakness in the residential construction market. Recent National Bank Business Confidence figures likewise showed a sharp slowdown in overall activity, and some claim that the indicator has now plunged to levels typically seen through times of economic recession. A largely ignored ANZ Commodity Price report was arguably the only bright spot for Kiwi economic data on the week, as the private bank reported that New Zealand producers are receiving considerably higher prices for their Commodity production. Such news was hardly a surprise, and the fundamental scales tipped further against the New Zealand dollar against major forex counterparts.

Given bearish economic momentum, it may take strong carry trade interest and a continued rally in global risky asset classes to keep the New Zealand dollar bid through the medium term. The high-yielding currency has already fallen considerably off of a double-peak above the $0.8200 mark in March, and price momentum remains weighed to the downside on a sustained downturn. The currency still enjoys the highest overnight and 3-month deposit rate of any G10 currency, but a clearly inverted yield curve shows that its interest rate advantage is likely to fade over time. According to over-the-counter swap rates, the 2-year NZD yield currently trades a full 70 basis points below the equivalent 3-month yield—almost squarely at multi-year lows. We feel that fundamentals currently weigh against the New Zealand dollar, and such factors may contribute to further medium term declines. Through the shorter-term, it will be important to watch for any significant shifts in global agricultural commodity prices and broader movements in risky asset classes.
Boris Schlossberg is a Senior Currency Strategist at FXCM.