Will the FOMC, Q1 GDP Bring the Dollar Back to Losing Status?

The US dollar staged a massive comeback last week as US economic data indicated that, while conditions remain dismal, they aren’t quite as bad as expected. First, the Richmond Fed index “only” fell to 0 from +6, versus expectations of a drop to -1, while existing home sales slipped 2.0 percent. Next, the headline reading of the Commerce Department's durable goods orders report contracted for the third consecutive month during March, due largely to declines in demand for transportation and defense goods. However, the markets took their cue from the durable goods orders excluding transportation reading, as the index surged 1.5 percent and helped to keep the US dollar rally alive.

Looking ahead to this week, Tuesday’s economic data will likely highlight some of the reasons why traders are ramping up speculation that the country is in midst of a recession. Indeed, the S&P/Case-Schiller index of home prices is likely to fall sharply for the fourteenth consecutive month. Later in the morning, the Conference Board’s consumer confidence index is forecasted to fall to a five year low of 62.0 from 64.5, which won’t be entirely surprising as rocketing food and energy prices combined with the collapse of the US housing sector and tightening credit conditions have sparked widespread pessimism throughout the financial markets. On Wednesday morning, highly anticipated Q1 GDP figures will be released, and a Bloomberg News poll of economists reflects consensus estimates for a 0.3 percent gain. However, these could be rather optimistic expectations, as there is a good possibility that GDP could actually fall negative.

Nevertheless, the market’s response may be muted as the FOMC rate decision will come at 14:15 EST and the Bank is forecasted to cut the fed funds rate by 25bps to 2.00 percent. However, the vote for the March reduction in the fed funds rate had two dissenters, both of whom voted in favor of “less aggressive” policy given upside inflation risks, and futures are now only pricing in a 75 percent chance of a 25bp rate cut and a 25 percent chance of no change in policy. The odds are certainly in favor of more accommodative policy, but if the concurrent policy statement suggests that the FOMC may not cut rates again at their next meeting, the US dollar could actually rally. The latter part of the week will see both ISM Manufacturing and Non-farm Payrolls, though the employment data will likely be the bigger market-mover. NFPs are expected to fall negative for the fourth consecutive month, indicating that consumer spending will continue to deteriorate as record high energy and food prices sap disposable income.

Euro – Will CPI Data Lead the ECB’s Hawkish Bias to Fade?

The Euro tacked on hefty losses last week amidst a rebound in the greenback and disappointing German IFO survey results. The measurement of German business confidence fell for the first time in four months, and led the euro to break below support at 1.58 within minutes. Indeed, rising energy and food costs, a strong regional currency, and tight credit conditions have dimmed the outlook for Europe’s biggest economy. Furthermore, ECB Governing Council member Michael Bonello killed the notion that every ECB member is hawkish, as he said during an interview with Reuters “I think current interest rates are sufficient for the medium-term strategy. I do not think that there is anyone who is considering higher interest rates."

Looking ahead to this week, EUR/USD price action will likely be contingent more upon US data rather than European releases. Nevertheless, it will be worth watching the figures scheduled to hit the wires on Wednesday. The Euro-zone’s unemployment rate is anticipated to hold steady, but consumer, economic, industrial, and business confidence are all expected to fall lower, much like we’ve seen in Germany’s IFO and ZEW sentiment reports. Surely the worsening status of the credit markets and rocketing commodity prices are creating less-than-optimal conditions for consumers and businesses alike. However, the key figure to watch will be the estimate for Euro-zone CPI in April. The index is forecasted to ease back to 3.4 percent from 3.5 percent, and if this is in fact the case, traders may quickly judge that the ECB will not continue to hold a firmly hawkish stance. Furthermore, if growth and sentiment gauges prove to be extremely disappointing, the markets may go so far as to consider the potential for a rate cut by the ECB when they meet again on May 8.

Yen’s Bullish Trend In Jeopardy As The Tides Of Risk Sentiment Change

There was a significant slate of Japanese economic data crossing the wires last week, but the docket’s collective influence on the yen would ultimately be redirected by a broad shift in risk appetite. Though lagging economic indicators around the world continue to show the malignant influence of the credit crisis, there has been a subtle yet notable shift in the market’s concern over the ongoing crunch. Investors were clearly on the hunt for yield last week with global equities rallying (the Nikkei 225 hit a two month high through Friday’s session), Japanese government bond yields surging and all yen-based currency crosses testing recent highs. However, the yen would ultimately fall short of setting new multi-month lows against its major counterparts – suggesting hesitancy in taking outright risk. The true turn will likely be held off until it is clear that monetary policy makers’ efforts to thaw the credit freeze through new liquidity schemes is paying off and banks are once again confident enough to lend without stifling haircuts and stringent requirements.

Despite the broad gravity that risk appetite continues to hold over the Japanese currency, there were a number of indicators that came across the wires last week that have altered the outlook for the domestic growth and interest rates. The biggest fundamental mover proved to be the consumer inflation reading for March. Just a few months ago, price indicators were third tier market movers offering firm support to dovish rate watchers; but conditions have changed rather quickly. Last month, the annualized reading of national CPI accelerated to a 1.2 percent clip – its highest in a decade. While a quick glance at the components clearly shows that the pressure is primarily from volatile food and energy prices (the core figure is a meager 0.1 percent), the figures are still a problem for policy makers. In fact, in response to the inflation data, JGB yields marked their biggest drop in five years. What’s more, the high level of inflation may finally mix with accelerating growth to require a policy shift from the BoJ. While many indicators are still pointing to slower growth, the leading economic indicators composite (used to forecast growth over the coming two quarters) rose for the fifth consecutive month to a new seven month high.

For the coming week, yen traders will have to stay on top of both risk trends and Japanese data. A close eye needs to be kept on the developments in the credit market to gauge whether lending is truly thawing. However, is not likely to come from any specific, economic announcement or indicator. Traders can more accurately react to the scheduled listings on the fundamental docket. The action begins early with the retail sales numbers for March. With consumer confidence at a five-year low, the outlook is not bright. The next string of releases hits early in the Asian session on Wednesday. Employment numbers and household spending will gauge consumer health, industrial production will monitor the business group and the BoJ rate decision will offer insight into the new policy board’s rate stance.

BoE Mortgage Bailout Sparks Week Of Volatility

The Pound saw another week of volatility as a BoE mortgage bailout plan, minutes from the MPC’s last rate decision , retail sales and first quarter GDP all influenced price action. The week started with the confirmation of the central bank’s plan to trade £50 billion in treasuries for mortgage back securities, that combined with a £12 billion rights issue by RBS spooked the markets and led to the cable falling. Then sterling bulls grab momentum on the back of record oil prices and inflation concerns, until the dovish minutes from the MPC’s meeting thwarted the rally. Governor King and the other voting members were far from a consensus with a 6-2-1 vote. Perennial dove David Blanchflower voted for a 50 point cut, while hawks Andrew Sentence and Tim Besley voted for rates to remain unchanged. Retail sales declined 0.4% in March, for the first time in three months, but an upward revision to the month prior left traders confused, before the week ended with the cable finding support as Q1 GDP printed inline at 0.4%.

Although, the U.K. economy grew at its slowest pace in three years, it was a relief to traders who were in a doomsday mindset. The picture for the British economy was starting to look gloomy as fears were heightened that the credit crisis was taking a bigger toll on the economy than had been expected, when the BoE warned that consumer spending and investment would continue to be impacted. The remarks combined with the mortgage bailout had traders speculating that several rate cuts may be needed to stabilize the housing sector and fuel future growth. Despite, retail sales and growth slowing the results were inline with prevailing expectations that the country was in a downturn but were far rosier than recent worries of the worse case scenario.

The Sterling has been trading in the wide range between 1.960 and 2.00 for nearly a month. The U.K. picture is so closely tied to the U.S. that neither side has been able to grab momentum. This week may offer the same volatility with the U.S. having the far more market moving data on the calendar. However, the U.K. docket will provide further clues to the state of the economy with consumer confidence , distributive trades and PMI construction on tap. The most event risk potential will come from PMI Manufacturing, if the U.K. producers have weakened more than expected it may lead to the cable breaking below the lower band of the current trading range.

Risk Appetite Sends Franc To Two Month Lows Despite Strong Data

Like the Japanese yen, price action in the Swiss franc was dominated by a rebound in risk acceptance. The currency’s correlation to yield appetite forced USDCHF to clear a range high, sending the pair to a near two month high near 1.04. Many of the Swissie crosses experienced moves of a similar magnitude including GBPCHF, EURCHF, AUDCHF and oddly enough CHFJPY. The drop in the yen-denominated pair is particularly interesting considering the Japanese currency is often considered the true proxy for risk. Over the past few weeks there has been a subtle shift in investor sentiment. Libor rates have eased, risk premium in default insurance and junk bonds has dropped and equities have rallied. This may be a sign that the cumulative efforts from central banks around the world is starting to take root. Just this past week, the Bank of England announced a new liquidity scheme that was similar to the Fed’s recent TSLF offering; but in addition to increasing the size of the injection and expanding the acceptable list of collateral to include mortgage-backed assets, the policy body took the additional step of extending the period of the loans to one year (with a possibility for extensions up to three years) – a necessary step to truly revive confidence in the credit market. Looking to the epicenter of the financial market crisis (the US), there are clear signs that the global endeavor is truly boosting investor and lender confidence. From the benchmark Treasury market, we have seen the biggest back to back weekly drop in two-year not prices since last 2001. What’s more, a recent auction for five-year paper saw the weakest demand since 2003. Both of these events suggests liquidity is more prevalent in the market. And, further showing a rebound in liquidity is sparking a demand for risk and yield, net corporate debt creation surged to $43.3 billion last week – the greatest demand on record (spurred by the greatest yields since 2001).

Outside the long-term ebb and flow of risk sentiment, this past week’s Swiss economic docket offered a list of indicators that was purely supported of higher Swiss rates and a strong franc. The upstream producer and inflation price index for March started things off with the greatest annualized price pressures in 19-years. The caveat though was, like many other country’s, the Swiss number was largely based on high energy and raw material costs. From the growth side of things, the first quarter reading of the Real Estate Index reported its strongest reading since 1992, countering a global trend towards deflating housing markets. Finally, even trade activity was strong. Demand from the Euro-Zone and Asia was countering record high franc and further sent exports for their biggest jump in over a year.

Over the days ahead, the economic calendar will no doubt take a back seat to the fickle state of global credit and financial markets – and the heavy-hitting US numbers will almost certainly have a weighted impact on risk appetite. When the currency market has time, however, the Swiss docket could have its way with price action. Staggered releases will cover the consumer, business activity and the outlook for the economy. The UBS consumer consumption indicator and SVME PMI are considered leading numbers. The KOF indicator composite however will a forecasted drop to a new two and a half year low – a dour outlook for health of the economy and the franc.

Bank of Canada Cuts Rates as Growth Prospects Falter

Canadian data followed a predictable trajectory last week. The Bank of Canada cut interest rates by 50 basis points as projected. Canadian inflation fell to just 1.4% in March, the slowest since January of last year. The BoC targets 2%, so the current lack of upside price pressure gives the bank substantial room to ease borrowing costs as sagging demand in the United States weighs on the export sector. The statement accompanying the release was decidedly dovish, stating that a “protracted” slowdown in the US will have "direct consequences for the Canadian economic outlook, with declining exports projected to exert a significant drag on growth in 2008." All signs point to the conclusion that further rate cuts ought to be expected going forward. Wednesday’s Retail Sales data for March validated the BoC’s assertions, showing contraction of -0.7% versus expectations of a 0.3% increase. This served to erode some confidence in ability of the domestic market to continue to act as a pillar of stability amid US-influenced declines in external demand. A BoC Monetary Policy report released on Thursday saw GDP growth forecasts slashed to 1.4% for this year, the slowest rate in 16 years.

This week will offer little by way of new insights, with February GDP figures the only significant item on the calendar. All signs point to a contraction, lending further credence to the current bearish bias. With nearly 80% of exports headed for US markets, the fate of the Canadian economy is firmly locked with that of its southern neighbor. USDCAD rose for much of the week, with more in the same direction likely going forward.

Australian Interest Rates to Remain on Hold as Inflation Surges

Australian data was focused on inflation last week, with Producer Prices for the first quarter starting things off with a printing at a record 1.9%. Predictably, prices for imported crude materials led the rise with an impressive 12.4% growth since a year ago on the back of the global rally in commodities. New Motor Vehicle sales offered a moderately supportive assessment of domestic demand as the metric swung back to positive territory to growth of 1% in March following a decline of -2.4% in February. The Australian economy is expected to slow under the weight of record-high interest rates, but a willingness by consumers to purchase big-ticket items such as automobiles may offer hope for an orderly easing in the pace of growth. First quarter Consumer Prices figures rounded out the week, surging to 4.2% from a year ago. Aside from rising energy and fuel costs that have been pushing up inflation globally, Australia's tight labor market was an important contributing factor to the buoyant reading. Growing demand for mining exports from emerging markets (notably China) have moved Australian firms to hire aggressively, stretching the available labor force and bidding up wages. With inflation at current levels, the Reserve Bank of Australia has virtually no scope to cut interest rates in the near term. On balance, an inherent lag in seeing the effects of monetary policy in the real economy means growth will continue to ease following the RBA’s aggressive posture last year. To that effect, Governor Glenn Stevens and company are likely to remain on the sidelines as they wait to see if expansion slows substantially enough to contain price growth.

Next week’s calendar is light on data, with March New Home Sales and Retail Sales amounting to the only substantial releases. Home Sales is meant to offer a reading on Australian consumers’ willingness to shell out for big-ticket items and take on debt. The metric is very volatile however, losing -5.3% in February but gaining 11.3% the month before. Traders would be wise to take this data with a grain of salt. Retail Sales offers a clearer picture, with another negative posting amounting to the third consecutive month of contraction in domestic demand. All things considered however, even a broadly negative result would not detract from Aussie dollar bulls’ long term conviction as Australian monetary authorities are among the farthest from cutting interest rates across the G7. With more rate cuts in the cards for North America and an increasingly moderating bias in the UK and Europe, the Australian dollar will continue to offer a lucrative yield advantage that is likely to take the currency higher across key pairings.

New Zealand Dollar Drops on Worsening RBNZ Interest Rate Forecasts

The New Zealand dollar slipped against its resurgent US namesake, as a deterioration in risk sentiment and outlook for domestic yields forced further losses across all NZD pairs. A Reserve Bank of New Zealand interest rate decision sunk forecasts for interest rates in the small Asia-Pacific economy, as increasingly dovish official rhetoric suggests that the RBNZ may look to ease monetary policy sooner than previously anticipated. The bank left its Overnight Cash Rate unchanged for its sixth consecutive meeting, and its attached statement suggested that “more markedly” weakening economic activity would limit the need for tighter policy in the foreseeable future. Officials cited sharp falls in consumer and business sentiment, tighter credit conditions, housing market deterioration, weaker prospects for global growth, and an ongoing drought as clear headwinds to further economic expansion. The dizzying list of risks to New Zealand demand was somewhat offset by a strong labor market, but it remains clear that momentum remains weighed to the downside for overall growth. The dovish tone surrounding growth outlook was summarily offset by officials’ hawkish stance on short-term price pressures, however; exceedingly high CPI inflation figures threaten to derail inflation expectations and longer term price stability. Given such an environment, the bank stands to leave its short-term policy rate unchanged for “a time yet”. Yet even here, these words represent a notably dovish turn from the phrase “significant time yet” used in the bank’s previous statement. The clear shift made for near-instantaneous losses in New Zealand dollar pairs, and an ongoing adjustment in risky asset classes only exacerbated Kiwi weakness.

The week ahead promises comparatively little New Zealand economic event risk, but a highly-anticipated US Federal Reserve interest rate announcement will almost certainly drive volatility in the global carry trade. Given equity markets’ extreme sensitivity to the Fed’s actions and statements, outlook for the New Zealand dollar may very well depend on whether or not the planned rate announcement will force further declines in world stock prices. Volatility in the US Dow Jones Industrial Average has fallen significantly through short-term trade, but there is a clear sense of unease across risky asset classes; traders are unsure of whether to believe that the worst of financial market turmoil is over. Any sign of trouble may bring swift declines in stocks and high-yielding currencies, and as such, NZD traders should keep a close eye out for the upcoming Fed announcement. Otherwise, it will be important to watch the results of Monday’s New Zealand Trade Balance report and the following day’s Building Permits survey.

Boris Schlossberg is a Senior Currency Strategist at FXCM.