Dollar: Doomsday Denied

The greenback traded with a positive tone all week long and Friday’s much smaller than expected contraction in NFP’s which printed at –20K versus forecasts of –75k only served to reinforce the notion that US economy may be simply in a slowdown rather than a full blown recession. As our colleague Kathy Lien noted, “Throughout this past week, there have been a number of upside surprises in the US releases including today’s non-farm payrolls report, first quarter GDP, Chicago PMI, and manufacturing ISM. Although we do not believe that the worst is behind us, this stability does indicate that the pace of the slowdown in the US economy has moderated.”

Furthermore, the buck is also be getting support on the interest rate front. We wrote that that after the FOMC decision, “Although US monetary officials did not explicitly state that they were going to end the easing cycle, the FOMC statement did hint that the committee may be changing its bias from dovish to neutral.

The long term implication of such a shift in policy should favor the dollar, as markets begin to appreciate the fact that most of the monetary adjustment by the Fed has already been made. With most of the rate cuts behind us, the greenback, which has been battered relentlessly due to unfavorable interest rate differentials, may now find some reason to rally.”

However, having pierced 1.5500 support level this week, after gaining more than 300 points the dollar may find next week a bit slow going. Next week the US economic calendar will not command nearly as much attention, with ISM Services and Trade Balance being the only possible market moving data points. The most important event next week will likely come from Europe when traders will focus on any change of tone from ECB chief Jean Claude Trichet at his monthly press conference. If Mr. Trichet makes even s casual suggestion of a shift to a neutral stance, the dollar may gain further, but if he remains hawkish we could see a rally back to 1.5600 as the week comes to a close. Still all things being equal, the EURUSD looks far more likely to hit 1.50 rather than 1.60 in the near future as market participants turn their attention to the slowdown in Europe rather than the problems in the US.

Euro – Will ECB President Trichet Back Off From His Hawkish Bias?

The Euro tumbled over the course of the week as data suggested that the European Central Bank may start to back away from their staunchly hawkish bias. Indeed, restrictive monetary policy appears to be taking a hefty toll on consumers, as German retail sales unexpectedly fell while retail PMI for the Euro-zone reached plunged further below 50, signaling contraction for the sector. As a result, it’s rather clear that weaker consumer spending will weigh on GDP figures for the first quarter, but will it be enough to convince the ECB to cut rates anytime soon? Unlikely. Estimates for Euro-zone CPI during April did ease to 3.3 percent from 3.6 percent, but this is still well above the ECB’s 2 percent target. Nevertheless, with growth prospects for the region waning rather quickly, political officials are going to be quick to voice their opinion that more accommodative policy is needed.

The biggest event risk for the euro this will be the European Central Bank’s policy meeting, as they are widely expected to leave rates steady at 4.00 percent for the eleventh consecutive meeting. The rate announcement will come at 7:45 EDT, but the big show is at 8:30 EDT when ECB President Jean-Claude 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, but if he suggests that price pressures will moderate in the near-term – as they have recently started to do – or that feeble financial market conditions are threatening economic growth, the euro could actually sell-off across the majors.

Yen: Will Risk Appetite Remain?

Dollar rose strongly against the yen last week, coming to within 30 points of the 106.00 figure as upward surprises in US economic data sparked a rally in stocks taking DJIA above the 13,000 level. Risk appetite is back, but will it remain? According to our technical analyst Jamie Saettele, the answer is no. As he wrote on Friday in Yen and Stocks: Don't Get Comfortable “The Dow has advanced nearly 1,500 points from its January low and lulled market participants into a complacent state that is common (and necessary) before a major price decline occurs.”

Indeed despite the better tone of trade in US equities this week, it’s hard to fathom how US companies could perform well in an environment of $4 gasoline and $4 milk. With prices for essentials rising to record highs, US consumers will have little left over for discretionary spending and as that reality begins to dawn on equity investors stock are likely to pull back taking USDJPY down with them.

On the economic front, the Japanese calendar is remarkably empty this week with only the LEI data on the docket. That in turn suggests that the pair will be even more influenced by risk assumption/risk aversion flows with 106.00 figure remaining key level of resistance in this snapback rally from the lows set in March.

Pound Remains Range Bound Ahead of Rate Decision

The Pound continued to trade within the 1.9600-2.000 range, testing both the high and the low last week. Inflation concerns and bearish dollar sentiment saw cable bulls fall short of the upper band at 1.9622 to start the week. Sterling momentum was reversed when the CBI distributive trades report crossed the wires at -26, over eight times lower the estimate of -3, leading the pair to test the lower band at 1.9622. U.K. consumers are starting to whither from the pressures of the current housing slump and rising energy and food costs, which has weighed on retailers outlook. The credit crunch remains a looming concern for the BoE as strict lending standards are suffocating the housing sector which saw mortgage approvals fall to a nine year low of 64,000. The BoE’s recent call for banks to re—capitalize, led to HBOS announcing a rights offering. The home lenders attempt at improving its current liquidity situation and better than expected manufacturing data provided support for the pound during the week. However, the Sterling continues to battle growing bullish dollar sentiment, which was fueled by a better than expected NFP print.

The tight credit markets remain an obstacle for borrowers and will continue to suppress house prices going forward and weigh on the British consumer. Central Bank Governor Meryn King has stated the “ratio of house prices to earnings will fall” and that although retail sales have been “surprisingly strong” consumer spending will fall, possibly quite sharply. The MPC leader would also reiterate the committee’s focus on keeping inflation near their target, which has led to speculation that the central bank will leave rates unchanged next week. However, others like committee member David Blanchflower are calling for immediate action to prevent the economy from slipping into a recession. The perennial dove voted for a 50 point cut at the last policy meeting and will look to push for further rate reductions going forward.

This week’s rate decision will be the major event risk for the week, with PMI services, consumer confidence and industrial production providing clues as to what actions the central bank may take going forward. The economy has remained resilient with service expected to follow manufacturing and remain in an expansionary phase. A week of strong fundamental data and a hawkish BoE could provide bullish pound sentiment. However, a rate cut or dovish statements from the MPC will spark considerable selling pressure, especially given the recent dollar strength. Especially with technical analysis showing a unorthodox trendline and considerable downside risk.

Franc Falls To A Two-Month Low As Risk Appetite Rebounds

The Swiss franc was the biggest loser among the majors this past week, with a near 2.0 percent drop against the benchmark US dollar that clearly defines the duel impact of the greenback rebound and the Swissie’s now unfavorable correlation to risk trends. Looking across the franc crosses, it was clear that the greatest impact on the single currency came from the upswing in risk appetite. Over this past week, market participants were back on the hunt for yield as signs that the cumulative efforts by global central banks the world over to thaw the credit crunch increased. In fact, a number of central banks stepped up their efforts to provide liquidity to the market just this past week. On Friday, the SNB, ECB and Fed announced a joint change to its policy. The US central bank announced that it was increasing the size of its biweekly TAF auctions from $50 to $75 billion, and that it was expanding its acceptable collateral to include high quality ABSs. Closer to home, the SNB announced it would increase its own US dollar repo auctions to every 14 days and that it double the amount available to $12 billion. These announcements in conjunction with positive growth signs in the US and better than expected corporate earnings numbers led to a general rise in risky assets and simultaneous drop in expected volatility. Implied volatility in USDCHF options reported the second biggest drop in the G10 (behind only USDCHF) while Dow, FTSE 100 and Nikkei reported gains of 1.29, 2.04 and 3.75 percent respectively.

Back in the usually mundane world of Swiss fundamentals, the economic docket was actually looking at a number of notable and leading indicators for traders to work with. Leading the action on Wednesday, the UBS Consumption indicator – used to forecast spending habits over the coming three months – slipped unexpectedly, though the indicator was still near its 9 month high. Among the major consumer groups, the auto component - the credit sensitive and discretionary spending leader – saw its first drop in 10 moths. For the business sector, things were looking up with an unexpected improvement – though this was a modest rise from a more than three year low. When everything was said and done, the most encompassing piece of data was ultimately the KOF leading indicators composite. Used the forecast growth over the next three to six months, the report printed its seventh consecutive contraction and its worst reading in over three years.

With the dour round of economic data that crossed the wires last week, traders will likely approach this week’s economic listings with caution. Tuesday’s consumer inflation reading will hold a greater than usual influence over the fundamental health of the franc with the SNB scheduled to meet next month and souring economic trends placing a greater burden on inflation to keep interest rates steady. Thursday’s employment report will hold less tout as the indicator has been seen incredible consistency in its improvement over the past year. Of course, a jump in joblessness could be quite the shock. And, of course, broad risk trends will likely take the lead on the Swiss franc’s direction.

US Slowdown Continues to Drag Canadian Growth Lower

Last week’s data proved bearish for Canada with February’s Gross Domestic Product readings posting a contraction of -0.2% versus expectations of an equivalent expansion. The annual figure now stands at 1.5% in the year to February, a reading well below the 10-year average of 3.8%. The outcome echoes recent actions by the Bank of Canada – the bank cut interest rates by 50 basis points this month, saying the slowdown in the US will have "direct consequences for Canadian economic outlook, with declining exports projected to exert a significant drag on growth in 2008." The Industrial Price Index (analogous to PPI) surged 1.7% in March on the back of an 8% jump in oil and coal prices. Excluding energy costs, the metric would have registered a meager 0.8% expansion. Though the headline figure was markedly higher than expected, it still falls below the BOC price level target of 2%. Coupled with last week’s CPI at 1.4%, the outlook for inflation is accommodative of further rate cuts going forward.

The Canadian calendar looks more robust this week, with March Building Permits and April’s Ivey PMI Survey starting things off on Tuesday. Economists expect business sentiment to contract with a PMI reading at 55.0 versus last month’s 59.0. While Thursday’s Housing Starts should pass with little fanfare, Friday brings a barrage of big back-to-back releases with Trade Balance and Employment figures. The pace of job growth slowed substantially last month, adding a modest 14.6k to the ranks of the employed. This month is projected to slow further with economists expecting a 10k increase. The trade surplus likely contracted as the spending slump in the US depresses exports.

Also of note, the historic correlation of the Canadian dollar with the price of crude has virtually evaporated in recent months. Oil has rallied sharply as speculators pulled funds from slumping equity and credit markets and dumped them into commodities. Meanwhile, Canada’s direct exposure to the US malaise has kept the loonie largely range-bound against the US dollar. Such breakdowns in the correlation have led to sharp corrections in past years. Tellingly, last week’s appreciation in the greenback saw weaker oil and a substantially stronger USDCAD. Should this mark the first steps in a corrective move to bring oil and the Canadian dollar back in line, a protracted rally in USDCAD may be in the works.

Australian Interest Rates to Remain on Hold as Economy Slows

Australian data continued to show signs of economic slowdown as the economy digests record-high borrowing costs at 7.25%. Business confidence fell to -4.0 in the first quarter, the lowest level since 2001. Confidence eroded most in those sectors most sensitive to rising borrowing costs such as retail, manufacturing, property and finance. As could be expected, confidence in the mining industry bucked the trend with a positive result. Australia’s mining companies have continued to reap the rewards of seemingly insatiable Chinese demand for their exports. At the other end of the spectrum, consumer spending perked a bit in March, printing at 0.5% having declined -0.1% in February. That said, the result does seem to indicate that Australians are paring back on non-essential expenses. Food and household goods sales led the increase, expanding at 1.7% each. Meanwhile, discretionary spending categories like clothing and hospitality sales plunged, declining -2.0% and -1.2% respectively. Sales in other areas posted smaller losses, but losses nonetheless. Following in the same direction, Building Approvals plunged nearly six times more than forecast, printing at -5.7% versus -1.0% expected. On the bright side, Australians continued to take out business and housing loans despite high interest rates as Private Sector Credit grew 0.8% in March.

The centerpiece of economic data for this week will be the monetary policy announcement from the Reserve Bank of Australia. All signs point to rates staying at 7.25% as Glenn Stevens and company continue following a wait-and-see approach, gauging the full effects of recent rate hikes materializing in the broad economy. Employment figures are likely to stay strong as expansion in the mining sector remains robust. March’s trade balance figures may see some improvement if overseas shipments rise with an expected 20% rebound in farm production. Though a continuation of this week’s US dollar rally would weigh on the price of commodity exports, the Australian dollar still maintains a distinct advantage against the majors with the RBA among the farthest from cutting interest rates across the G7. The lucrative yield gap and a moderation in risk sentiment are likely to remain compelling arguments for Aussie strength.

New Zealand Dollar Downtrend likely to Continue on Falling Yields

The New Zealand dollar traded marginally lower against its US namesake on the week, as a sharp greenback rally and commodities tumble offset a broader recovery in risky asset classes. Domestic stock markets improved nearly 3 percent off of intra-week lows, and the US Dow Jones Industrials Average posted similarly robust gains. Yet the popular CRB Commodities index fell significantly off of recent peaks—forcing similar moves in the raw materials-sensitive New Zealand Dollar. A disappointing Trade Balance report likewise dimmed fundamental prospects for the Asia-Pacific currency; the domestic economy unexpectedly produced a small trade balance deficit through March on a noteworthy slowdown in Exports. Many now wonder whether the Kiwi can reverse its recently poor fortunes, as a cursory look at NZDUSD, NZDJPY, and AUDNZD charts reveals a clearly bearish NZD trend. Yet the coming week is unlikely to clarify or improve outlook for the New Zealand dollar; ostensibly important labor data is unlikely to change forecasts for the future of domestic growth.

Overall developments in commodity markets and broader risky asset classes are likely to be the most significant drivers of New Zealand dollar volatility through short-term trading. Markets largely expect that upcoming NZ Wages and Employment Change figures will reflect previously strong labor market trends, but any positive surprises are somewhat unlikely to change sentiment on the broader economy. As with any economy, domestic labor data is simply a lagging indicator for economic trends. A broader global slowdown, an ongoing NZ drought, and a nascent reversal in commodity price gains all threaten outlook for the future of domestic expansion. As such, it will be important to watch for developments in more timely economic indicators. In the meantime, the bearish term structure of New Zealand dollar interest rates suggests that markets expect a significant pullback in growth. With the spread between 3-month and 2-year swap rates at its most negative in at least 10 years, traders are aggressively pricing in rate cuts from the Reserve Bank of New Zealand. It is too early to claim that the RBNZ will loosen monetary policy through the coming months. But the mere fact that NZ interest rates have likely peaked will continue to weigh on the traditionally high-yielding domestic currency.

Boris Schlossberg is a Senior Currency Strategist at FXCM.