Dollar: 1.60 Does Not Fall Yet
We wrote on Friday, that “The 1.60 figure remained tantalizingly out of reach for euro bulls for yet another day, as many option barriers at that level remained well protected. Having failed to break that level four times over the past few days, the EURUSD weakened in quiet overnight trade as bears tried to capitalize on lack on momentum and push the pair below the 1.5900 figure.”

Ironically enough, late week the market was looking for any vulnerability in EZ data assuming that US data would prove predictably dour. However, US economy registered several positive surprises last week with Empire Manufacturing and Industrial Production both printing far better than expected. The last possible argument of dollar bulls – namely that the weakness in the currency would fuel growth in US manufacturers offsetting some of the downward pressures in finance and housing sectors - turned out to have some merit and helped keep dollar from collapsing further.

Next week the US calendar is nearly barren with only Existing Home Sales and Durable Goods orders on the docket. The housing numbers are forecast to dip below the key 5MM annual run rate once again, but given the low expectations are not likely to have any meaningful impact on price action. The Durable Goods report will be of far greater interest to traders if the weak-dollar-will-help-manufacturers argument is to have any legs. Ultimately however, it is the EZ data that could hold sway next week. 1.60 hasn’t fallen yet, but it may be just a matter of time.

Euro: The Week of Truth
Despite the dual headwinds of high exchange and interest rates, the economic data from the EZ continued to favor the euro last week. German Producer Prices reached a 15 month high on rising energy costs and even Italy, which has been the weakest link amongst the 3 major European economies, showed a surprising strength as Industrial Orders jumped 2.0% versus –1.0% expected. For the time being the decoupling thesis remains in place and on the fundamental basis the euro is not only benefiting from relatively buoyant economic performance in the EZ but also from hotter than expected inflationary data which is likely to keep the ECB stationary for quite some time.

This week however may the moment of truth for the euro bulls as both Manufacturing and Services PMI data are expected to hit the screen on Wednesday. Analysts forecast a slight decline in both gauges but expect them to remain above the key 50 boom/bust level. If, however, they contract sharply and perhaps even fall below 50, that may be just the type of catalyst the market is looking for to push the pair lower, especially if the IFO report that follows on Thursday confirms the downward trend.

Just as the dollar is benefiting from lowered expectations, the euro may be vulnerable to heightened ones. Therefore any slip in the data could pull the pair lower as traders start to anticipate the spillover effects from the US slowdown. On the other hand, if the data continues to confound the bears and continues to be positive another run at 1.6000 will most likely occur as euro longs will be emboldened to take out the barriers at that key level once again.

Japanese Yen Falters as Carry Trades Recover
The Japanese yen fell 2.6 percent against the US dollar last week as traders piled back in to risky assets. The move came amidst surprisingly strong first quarter corporate earnings reports from firms like Google and IBM. However, given the massive $5.1 billion net loss at Citibank, it is clear that the subprime crisis and subsequent credit crunch has taken a hefty toll on the balance sheets of financial institutions. Meanwhile, the minutes from the Bank of Japan’s March meeting indicated that the central bank would likely continue to leave rates on hold in coming months. Furthermore, the Bank of Japan’s nine policy board members reiterated the need to pay close attention to increased downside risks to the Japanese economy given the intensifying slowdown in the US and persistent instability in the global financial markets. The board also agreed to maintain the Bank's “basic thinking on monetary policy for the future,” suggesting that decisions will continue to be made with the aim of maintaining price stability.

Looking ahead to this week, inflation data will remain unsettling as National CPI is forecasted to edge up to an annualized 1.2 percent pace, as energy and food prices skyrocket globally. Meanwhile, the release of the Tertiary Index is anticipated to reflect slowing in the Japanese services sector, as consumption remains weak. This will likely weigh heavily on the headline All-Industry Activity Index later in the week, as the service sector composes a large portion of the figure. Nevertheless, the biggest driver of day-to-day price action in the Japanese yen pairs remains risk trends, and downside potential for USD/JPY remains broadly to the downside. Indeed, as Technical Strategist Jamie Saettele mentioned in a special report, the spike in USD/JPY is simply a big countertrend move.

Data Leads To A Volatile Pound, Data Promises The Same This Week
The British pound was very volatile last week and rightly so - not only was the economic calendar populated by a number of top market moving indicators; but the ongoing disruption in global financial markets has pushed the UK’s yield and economy to the edge. From the definable docket, there were more than a indicators that would drove the pound for short bursts of activity – and a few that may have altered the sterling for the long term. In fact, the pound would be put into action at the very start of the week when the March PPI numbers crossed the wires much higher than expected, elevating inflation concerns only a week after the Bank of England cut rates for a third meeting. This data would ultimately drive a 200-plus point rally in GBPUSD, but where fundamentals would initiate the move, it would also end it. Then, later that same day, market participants were reminded why the MPC has been turned to a dovish regime. The leading BRC retail sales monitor reported its first drop in two years while the RICS House Price Balance offered its worst reading since records began back in 1978 with a -78.5 percent read. After this early flood of data though, the influence of the calendar faded with less market moving data and weaker economic surprises. The CPI reading was released the following day with little fanfare. Though the 2.5 percent headline clip matched the highest reading in 11 months, the weak 1.2 percent core reading shows that upstream inflation is still heavily influenced by a few components that could quickly reverse.

Outside the pull of the economic docket, the pound’s main driver was the health of the financial markets – local and global. Over the week, policy officials made a significant go at encouraging confidence in domestic lending markets. Prime Minister Gordon Brown and Treasury officials have both suggested a government plan aimed at thawing the mortgage and credit market will be finalized next week. However, until action is taken, lending and borrowing are still struggling in the UK. When the BoE injected £13.7 billion into the markets, the bank received £50 billion in bids – suggesting banks and lenders are still struggling to find liquidity in the still unstable markets.

Looking out over the week ahead, risk consideration will almost certainly carry over the weekend. With the government’s assurances of a plan to help out the burdened mortgage and credit market, investors will quickly absorb any hard policy that could reasonably mend the market and turn the news into a pound advance. Data will certainly have its place in price action as well. The week opens with the Rightmove housing inflation indicator (and the nationwide number is scheduled sometime over the coming week). After the RICS dropped to its lowest level on record, the market will no doubt keep a close eye on the health of the housing market. Retail sales and the BoE minutes hold potential, but do not promise, price action from the pound. On the other hand, Friday’s advanced reading on first quarter GDP will no doubt capture the interest of all traders as it represents the leading gauge of activity for the industrialized world.

Franc Loses Luster on Return to Risk – Additional Losses in Store?
Like the Japanese yen, the Swiss franc lost out as increased risk appetite led carry trades and equity markets to surge higher. Indeed, the Swissie lost 1.6 percent against the greenback amidst mixed Swiss economic data. First, Swiss retail sales more than doubled expectations of a 1.6 percent gain with a 3.3 percent surge in February. This was the 21st consecutive month of growth and the highest since September 2007. Looking at the complete breakdown, there were improvements in furniture, electronics and household goods, which shows that consumers are still spending their discretionary income. However, the majority of the gain was in food and beverage sales – and since this index is not adjusted for inflation – it is clear that the index benefited from record commodity prices. A labor market at full employment has fueled consumer spending and optimism that the economy can withstand the US slowdown, but with price pressures building significantly, disposable income may only be able to remain robust for so long. Meanwhile, the ZEW survey of Swiss sentiment improved very slightly to –71.4 in April, as investors remain jittery given the broad risks in the markets.

This week, Swiss data is expected to give the Swiss National Bank far more leeway to cut rates – though they are not anticipated to do so in the near-term – as producer and import price growth is forecasted to slow, while the trade balance is likely to narrow. The biggest driver of major moves in the Swiss franc pairs remains risk trends, and downside potential for USD/CHF is broadly to the downside. Nevertheless, in the near-term, USD/CHF could continue to rally, as Technical Strategist Jamie Saettele mentioned in Friday’s Daily Technical Report.

Does Weak Canadian Inflation Guarantee a 50bp Cut?
Like most of the dollar-based majors, the USDCAD saw incredible volatility last week – though the pair is still within the confines of a broad range. Looking back over the past week, the it was clear that the loonie is struggling to hold its ground against the significantly oversold US dollar. No doubt acting as a last line of defense for many Canadian dollar bulls, energy and commodity prices are still used as a solid reason to hold onto the currency. For loonie, the key commodity move was the jump in crude to a new record high just above $117 a barrel. As we have said before, this factor alone will act as an anchor for USDCAD as Canada is the largest energy supplier to the US. Therefore, until crude falls significantly, loonie traders will hesitate in joining any major USDCAD rally.

And, looking at the influence the economic docket was having on the outlook for Canada, we can get a better sense as how difficult it is becoming to hold back a fundamentally-driven USDCAD advance. The heavy hitting data held off until the end of the week. Thursday brought the indicator with the most market moving potential – the consumer inflation numbers. Economists were already expecting front-line price pressures to cool through March; but the actual numbers will undercut even the pessimistic economist. Statistics Canada reported a deceleration in the headline, annualized figure to a 1.4 percent clip for the lowest reading from the series in 14 months. Even more dovish was the core number stepped down to a 1.3 percent pace, its worst reading since July of 2005. On the following day, the week was closed out with second tier indicators. March’s leading indicators index (used to forecast growth over the coming three to six months) matched expectations by showing no change. This is the fourth time in five months were the growth outlook has failed to predict expansion from the world’s eight largest economy. Finally, the wholesale sales report marked a sharp 1.8 percent drop in business to business sales as retailers and other second buyers prepared for a slowdown in consumer spending.

While last week’s indicators may have had limited impact on the Canadian dollar, they will have another chance at moving price as leading indicators for this week’s numbers. Two major fundamental announcements are scheduled for release over the coming days - Tuesday’s Bank of Canada rate decision and Wednesday’s retail sales report. The policy decision is the event risk with the greatest market moving potential with economists expecting another 50bp rate cut. At its last policy meeting, the Canadian policy group took the seemingly dramatic step of cutting its benchmark lending rate a half percent to 3.50 percent. With the cooling in CPI last week, traders are confident that the BoC will act with another large rate cut. However, with growth still promising for the economy and financial markets relatively stable, a 25bp cut could be easily justified. And, though it will be released after the volatile BoC decision, the retail sales number could move markets by gauging consumers’ spending habits in the global economic slowdown. After a sharp 1.5 percent jump in sales in February, economists are expecting a modest 0.3 percent increase last month, which finds confirmation from the leading composite index and wholesale sales.

Carry Trade Demand Fuels Australian Dollar Rallies
The Australian dollar moved significantly higher against the Japanese Yen and other major counterparts, as a resurgence in carry trade demand boosted demand for the high-yielding currency. Indeed, the Aussie now trades over three percent improved against the Yen, and it is likewise one of only three G10 currencies to move higher against the US dollar on the week’s trade. Fresh fundamental developments for the Australian economy were nonetheless underwhelming; dovish Reserve Bank of Australia rhetoric further sunk hopes for higher domestic interest rates through year-end. The spread between the 2-year and 3-month benchmark AUD swap rates remained in clearly bearish territory at -35 basis points—near its worst levels in seven years. Such poor yield expectations would normally be enough to sink any given carry trade-sensitive currency, but similarly bearish forecasts for US and Japanese interest rates have arguably kept the Aussie bid. The same remains true for AUD strength against its New Zealand counterpart; the Kiwi has clearly lost ground on expectations for fairly aggressive RBNZ rate cuts in 2008 and 2009. That said, the Australian dollar is somewhat likely to ignore developments in domestic yield expectations and instead move on general shifts in global risk sentiment.

The week ahead will likely see the Australian dollar trade lockstep with the Dow Jones Industrials Average and other key risk barometers, while ostensibly significant domestic inflation reports are less likely to force major moves across AUD pairs. Official Reserve Bank of Australia releases show that the central bank has discounted high inflation figures through the coming quarters in its current stance on monetary policy. As such, it would take a surge or a tumble in CPI figures to make a significant impact on RBA rate expectations—neither of which seem especially likely. Thus it will be most important to watch overall developments in global risk sentiment. If global stock markets continue their recently torrid pace, we could easily see the Australian dollar higher against the Japanese Yen and other low-yielding counterparts.

New Zealand Dollar Could Stumble on Risk Aversion
The New Zealand dollar fell modestly against its US namesake to finish the week’s forex trading, as disappointing economic developments sunk forecasts for the future of domestic growth. Yet a resurgence in the global currency carry trade made the NZD a significant gainer against the low-yielding Japanese Yen—climbing an impressive 2.3 percent through Friday’s New York close. Strength against the Yen notwithstanding, the New Zealand dollar showed fresh signs of weakness against major forex counterparts. An early-week Retail Sales report showed that spending fell a disappointing 0.7 percent through February—worse than all 11 analysts’ estimates as reported by Bloomberg News. Later-week Consumer Price Index data likewise printed a shade worse than previously predicted and only worsened outlook for the future of domestic interest rates. Indeed, the key 2 year-3 month NZD swap spread now trades at a dismal -77 basis points—near its worst levels in at least 10 years. Bearish rate forecasts will, all else remaining equal, weaken the currency through the medium term. Yet such a scenario will likewise depend on rate expectations for major forex counterparts.

Markets expect that the Reserve Bank of New Zealand will leave interest rates unchanged at its upcoming announcement, but any indication that the RBNZ stands to take rates lower through 2008 will almost certainly force a sell-off in the high-yielding domestic currency. All eyes will turn to RBNZ Governor Alan Bollard for any indication on the future of monetary policy. Previous rhetoric suggests that the bank expects inflation will moderate through the longer-term, but currently above-target CPI levels are cause for concern. It will thus be important to gauge whether or not the RBNZ—a strict inflation-targeting monetary policy body—will be free to cut rates as domestic expansion slows. The calendar remains otherwise empty for the New Zealand dollar, but it will be important to monitor developments in global risky asset classes. Given that the carry trade remains closely linked with the Dow Jones Industrial Average, Japanese Nikkei 225, and other risky asset indices, a reversal in stock market gains could easily force similar retracement in the NZD.

Boris Schlossberg is a Senior Currency Strategist at FXCM.