Dollar Tests Two Month Highs As Sales Activity Improves
The relative quiet of the economic docket has proven to be a boon for the dollar’s evolving reversal so far this week. Through Thursday’s session the greenback climbed to a more than two-month high against the euro, British pound and Swiss franc. And, while fading fundamentals on the other side of these pairs contributed heavily to the moves; we did receive a few leading indicators from the US calendar, and each brightened the outlook for the world’s largest economy. The action began early with the weekly jobless claims numbers. First time filings through May 3rd fell more quickly than expected to 365,000 while the cumulative continuing claims figure slipped from its upwardly revised figure to 3.02 million. However, while the changes are in the right direction, they certainly don’t point to a rebound in NFPs anytime soon as the four-week moving average for each read is still near a four-year high. Later in the session, a couple of second tier sales figures gave the market reason to second guess economists’ forecasts for next Tuesday’s retail sales report. The Commerce Department reported an unexpected 1.6 percent jump in March wholesale sales led by a 4.5 percent surge in auto purchases. A more direct connection to next week’s report can be drawn from the ICSC’s chain store sales report. According to the proprietary gauge, retail sales rose 3.6 percent in the year through April - the biggest improvement in over a year - helped by activity at discount and wholesale clubs.

Hawkish Outlook From ECB’s Trichet Turns The Euro From Early Losses
Before ECB President Jean Claude Trichet would cross the wires with his persistently hawkish outlook for monetary policy, the euro was on the retreat across the board Thursday morning. The European session was dotted with disappointing German trade and factory activity data. The industrial production number for March proved to be the most discouraging with a 0.5 percent contraction that met expectations for the sharpest contraction in 11 months - helped specifically by a remarkable 12.3 percent tumble in construction activity. Aside from these indicators, top event risk was naturally the ECB rate decision. While the policy body held rates unchanged at 4.00 percent as expected, President Trichet’s public address quieted speculation of an impending dovish turn. In his remarks, the policy maker said inflation was the group’s “highest priority” and that risk was clearly to the upside. He further suggested data pointed to moderate, ongoing growth and that financial market turmoil was putting little constraint on lending with money and credit growth “still vigorous.”

British Pound Holds Above 1.95 as Bank of England Leaves Rates at 5.00%
The British pound managed to hold above the 1.95 level on Thursday as the Bank of England left rates steady at 5.00 percent. The move was in line with expectations, but given the continued deterioration in UK economic data, there had been some speculation that the Monetary Policy Committee would vote in favor of a 25bp cut. Nevertheless, the BOE tends to take a slow-and-steady approach when it comes to changing monetary policy, and given the upside risks to inflation looming from booming commodity prices, it is not entirely surprising to see that they left rates unchanged. However, when the minutes from the meeting are released on May 21, the news could be bearish for the British pound as there were likely at least one or two votes for a rate cut and widespread concerns regarding downside risks to growth, which we noted in our BOE Rate Decision preview on Wednesday.

Commodity Currencies Encounter Heavy Event Risk From Employment Reports
The New Zealand and Australian dollars traded relatively quietly during the US trading session, but only after experiencing a surge in volatility in the Asian session as labor market reports from both regions proved surprising. First, the New Zealand unemployment rate jumped more than expected to 3.6 percent from 3.4 percent, as the labor market lost 28k workers during the first quarter, which sent the NZD/USD plummeting over 100 points within minutes. Indeed, it appears that the Reserve Bank of New Zealand’s record high rates of 8.25 percent are having the intended impact by leading consumption to drop, business activity to cool, and inflation pressures to ease. Given these developments, if CPI continues to fall lower, the RBNZ will finally get the green light to start cutting rates. On the other hand, the Australian dollar jumped on news that the economy added on 25.4k workers, much more than the expected gain of 14.8k, while the unemployment rate rose to 4.2 percent as more people entered the market looking for jobs. The tightness in the Australian labor markets and subsequent rise in salaries has only stoked inflation concerns, and while domestic demand has started to fall, the Reserve Bank of Australia still remains hawkish and thus, will likely leave rates steady at 7.25 percent for much of the year. Meanwhile, the Canadian dollar fell across the board as Canadian housing starts fell more than expected to 213.9k units in April, led by a drop in apartment and condominium projects, down from a revised 243k in March. However, the big event risk for the Loonie comes on Friday as the Canadian net employment change will be released. This number is essentially “the other NFP report”, as the data tends to be highly market-moving for the Canadian dollar and rarely meets estimates. For more on how the Canadian net employment change may impact the Canadian markets including USD/CAD, check out Cross Market Reactions.

Yen Backed By Risk Aversion, Docket’s Only Data This Week Due
The yen enjoyed a broad advance across the FX market today as investors trimmed back their risk-taking ahead of the week’s close. Looking ahead to Friday, we will receive the only piece of Japanese data scheduled for release through this holiday-shortened week. The preliminary reading of the March Leading Economic Index (used to forecast growth over the coming three to six months) is expected to fall to a reading of 20 percent. Not only would this point to slowing growth, it would also break the gauge’s steady five-month improvement.

Kathy Lien is the Chief Currency Strategist at FXCM.