Big Week Ahead for the US Dollar
After a quiet start to the week, volatility has returned to the currency market. The moves that we have seen over the past 2 trading days are just a taste of what we expect for the week to come. With consumer spending, inflation, manufacturing and housing market data on the calendar, the EUR/USD is prime for a breakout. The US dollar has already weakened significantly today as trouble on Wall Street spills over to the corporate sector. For the first time in 5 years, General Electric reported a quarterly drop in profit. Their Financial Division was hit the hardest as the Bear Stearns debacle forced GE to write down its assets at very low values, resulting in a 42% increase in loss provisions. Frontier Airlines also became the fourth airline to file for bankruptcy this month. The 3 others were Aloha, ATA and Skybus.

Although Frontier credited their bankruptcy to “an unexpected attempt by its principal credit card processor to substantially increase a holdback of customer receipts,” rising fuel prices have contributed substantially to the failure of these 4 airlines. This proves that those economists who say core prices is the only thing that matters are wrong because prices including food and energy is crippling the global economy. The weakness of the dollar was exacerbated by the sharp drop in consumer confidence. According to the University of Michigan, consumers have not been this pessimistic in 26 years. The problems in the US labor and housing markets combined with rising prices are becoming too much for the average American to handle. On Monday, we will see whether the rise in prices will offset the contraction in consumer spending. We believe that 3 months of net job losses will make it difficult for most Americans to be liberal with their spending.

Retailers around the nation have been closing shops, Kimberly-Clark Corp has increased prices on everything from Huggies diapers to Cottonelle bath tissue and even Las Vegas casinos are reporting a decrease in gaming revenues. With this in mind, we continue to expect further dollar weakness, particularly against the Japanese Yen.

British Pound Falls to a Record Low
The British pound dropped to a record low against the Euro as problems continue to plague the UK mortgage sector. Last month, I indicated that the British pound could fall below 2.0 if disaster hits UK mortgage lenders. Since then, the pound has traded lower and even though there has been no blowup, nearly every major UK mortgage lender has either increased their interest rates on mortgages or withdrawn from the mortgage market completely. Despite the Bank of England’s 25bp rate cut yesterday, UK mortgage lenders have not relaxed. In fact, Abbey National, the last remaining lender to offer 100 percent mortgages has pulled their products off the market. The Bank of Ireland has also completely withdrawn their mortgage products for eight days while they reassess the value of their home loans. Existing lenders are expected to continue to hike borrowing costs, making it even more difficult for the UK housing market to recover. Next to the US dollar, the British pound is the currency that we are most bearish. However, next week could bring some respite with inflation and employment reports due for release. Even though the economy is deteriorating, the employment components of the PMI reports suggest that the labor market could actually rebound.

Breakout Expected in the Euro
The Euro is consolidating within 100 pips of its high against the US dollar. For traders that like technicals, there is a clear ascending triangle forming in the EUR/USD which indicates that the currency pair is prime for a breakout. Wholesale prices in Germany were stronger than expected, confirming the ECB’s fears about inflationary pressures. In the week ahead, US data dominates the calendar with only the German IFO report, Eurozone consumer prices and producer prices due for release.

Australian, New Zealand and Canadian Dollars Drop in Rising Risk Aversion
Rising risk aversion and the 250 point drop in the Dow has driven the Australian, New Zealand and Canadian dollars lower against the greenback. New Zealand reported their REINZ house prices, which hit a 7 year low, as record high interest rates start to take a toll on the overall economy. Next week’s retail sales figures are also anticipated to drop, as personal savings grow. In contrast, New Zealand’s consumer prices and food prices should report cheery figures, as dairy prices remain high. With economic slowdown creeping into the picture, RBNZ officials show no remorse, as wage pressures continue to boost inflationary pressures. On the other hand, Australia did not have any releases, but yesterday’s unemployment report indicated that the once resilient economy is starting to weaken. Next week’s depressed home loan and investment lending releases will prove to investors that the housing sector is already in a slump. On the Canadian front, new housing prices grew at a slower pace than anticipated, as the housing market starts to mimic the US housing market. Next week’s CPI releases indicate that inflation is slowly approaching the 2% safety zone, but it should not be a concern for officials.

Yen Crosses Rally Ahead of G7
After a week of relatively consistent losses, the Japanese Yen had an unexpected gain today on the unwinding of carry trades. If this trend should continue over the few trading sessions, there is potential for the Yen to end up near its support level of 95. With no economic news released\, investors look forward to next week, with the G7 meeting and BoJ minutes due for release this weekend. This should set the tone for Monday’s trading session, along with providing investors vital information about the issues that are of main concern for officials.

Kathy Lien is the Chief Currency Strategist at FXCM.