Dollar Rally Runs Out of Gas

After reaching 1.5283 in early Wednesday trade the dollar rally ran out of gas for the rest of the week as uber hawkish Jean Claude Trichet dismissed any possibility of near term rate cuts causing a quick short covering rally in the EURUSD. For the week however, the US data produced mainly positive surprises suggesting that the economy may be faring far better than most analysts forecast. The most impressive news on last week’s calendar was the sharp rebound in ISM Manufacturing report which printed at 52.0 versus 49.1 expected. With services data which comprises the vast majority of US economic activity, squarely above the 50 boom/bust line, the arguments for an imminent US recession have become considerably less persuasive.

Nevertheless, next week may be a considerable challenge for dollar bulls as most of the US economic data is expected to be rather weak. The tone of trade will likely be set by Tuesday’s Retail Sales numbers which are projected to contract by -0.2% from the month prior. However, given the sharp rise in gasoline which comprises a significant part of the report, the possibility of an upside surprise exits. If that were to occur, dollar’s counter trend rally may pick up steam, but greenback bulls will still face a number of obstacles as a series of manufacturing releases including Industrial Production are all expected to show further deterioration.

Overall next week promises to be one of grinding consolidation with the pair bounded by 1.5600 to the topside and 1.5300 to the downside. It’s clear that intermediate sentiment has turned in dollars favor, but the staunchly hawkish attitude of the ECB continues to prop up the euro. Barring any negative surprises from the US calendar, the pair is more likely to be driven by European news especially if EZ data continues to signal a slowdown.

Euro – Trichet is Tough

“The EURUSD continued its rebound from multi-week lows in the aftermath of yesterday’s very tough, unapologetically hawkish press conference by ECB President Jean Claude Trichet, “ we wrote on Friday. “Mr. Trichet’ s take no prisoners stand surprised some market players who expected a more conciliatory tone that would acknowledge the growing evidence of an economic slowdown in the Euro-zone. Yet tonight’s economic data perfectly reflects ECB’s dilemma. German wholesale prices registered a gain of 6.9% on a year over year basis as energy costs continued to expert enormous price pressures on the country’s producers while at the same time French Industrial Production fell –0.8% versus –0.4% expected. The EZ economy is clearly experiencing the worst of both worlds as it simultaneously faces contracting demand and rising prices.”

Next week that tension between growth and inflation will be tested once again as EZ CPI data will print along with the GDP numbers and markets will get a better sense of the underlying strength of the EZ economy. If, as we suspect, the GDP numbers disappoint to the downside, the EURUSD may resume its three week long slide. If however, the GDP data meets or even beats market expectations, the decoupling thesis will remain alive and given Trichet’s unswerving focus on inflation euro bulls will try to make another run to 1.60.

Japanese Yen Surges As Risk Aversion Returns

Japanese economic data was extremely light last week following the completion of the Golden Week holidays, while the only indicators released sparked little fanfare as they met expectations. The country’s leading index fell to 20 percent in March from 54.5, signaling that growth is likely to slow over the next two quarters. Indeed, the index has been below 50 in nine of the past twelve months, and it is rather clear that waning demand for Japanese exports is taking a toll on the economy as a whole. Nevertheless, it was risk trends that drove Japanese yen price action, especially as multi-billion dollar losses at UBS and Fannie Mae, amongst others, weighed on US stocks. Furthermore, oil continued to rocket to fresh record highs and eventually topped $126/bbl, adding to downside risks for the global economy.

For the coming week, money supply and broad liquidity figures are expected to be unchanged, as BoJ officials remain reluctant to increase liquidity in fears of fueling further inflation. In contrast, bank lending and machine tool order figures should decline, as businesses remain skeptical about global demand, and contain themselves from expanding. Bankruptcies and Eco Watchers Survey figures should be gloomy, as dejected consumers cut back on spending, and in the process hurting overall business sentiments, as local demand for products continues to decline. Near the end of the week, Machine Order, GDP and Consumer Confidence figures should help confirm investor fears that the once recovering economy has slowed again. Nevertheless, risk trends will remain the primary driver of the Japanese yen, and with implied volatility for the currency surging, the USD/JPY could be in for hefty declines.

Pound Comes Under Selling Pressure, Despite A Balanced BoE

A U.K. bank holiday got the week off to a slow start, but the remainder was disappointing for pound bulls. A weaker than expected April PMI services report printed at 50.4 against an expected 51.7,its lowest reading in five years. The disappointing read in the sector which accounts for 75% of the economy spark bearish sentiment that would remain throughout the week. U.K. March industrial production declined 0.5% from a 0.4% gain the month prior, with reduction in automobiles, food and beverages leading the way. The result demonstrated the weakening British consumer in the face of inflation, housing and credit headwinds, leading to consumer confidence falling to a four year low of 70 from 77 in March. Pound bears would send the currency to an eleven week low ahead of the BoE rate decision. Although, the central bank’s rate decision promised to be the major event risk of the week, a rate hold and a balanced statement did little to deter bearish sentiment.

The British Monetary Authority voted to keep its benchmark rate unchanged at 5.00% after a quarter point cut the meeting before. The decision was expected to be close considering the preceding dour fundamental data, with some speculating that a surprise quarter point cut may be forthcoming. The tone of the subsequent commentary was slightly more hawkish than expected with the central bank issuing a balanced statement warning of the increasing risks of rising global inflation and cautioning of continued downside risks to the economy. Inflation stands at 2.5% well above the 2% target, and threatening to breach the 3% threshold, which requires Governor King to write a letter of explanation to Chancellor Alistair Darling. Nevertheless, the economy has shown clear signs of contracting, leading to speculation that a quarter point cut will come at the June meeting.

The week ahead will present considerable event risk with trade, inflation and employment data on tap. Exports have increased the last two months and if the trend continues it may provide sterling support, conversely weakening global demand may leave the U.K. with no sources of growth. The expected increase in inflation may reinforce the BoE’s concerns, but may not provide its traditional bullish sentiment with the expectations of a rate cut. A declining labor picture may have the greatest potential impact on the pair, as job losses would compound problems for Britons, who are battling rising inflation and a slumping housing market.

Swiss Franc Rebounds Despite Signs Economy is Slowing

The Swiss franc rebounded over the course of the week, but as usual, the move had little to do with domestic data and instead was fueled by a market-wide return to risk aversion. Taking a look at the data on hand, consumer price growth slowed to a 2.3 percent annualized pace in April, down from 2.6 percent in March. While record food and energy costs are keep inflation pressures robust, weakening demand for private services and durable goods are helping to counteract this trend. Meanwhile, the seasonally adjusted unemployment rate rose for the first time in nearly five years in April, indicating that a slowdown in the economy may be starting to hit the labor market.

Looking over the coming week, fundamentals may still lack substantial influence over price action, but they will give further insight into the status of the Swiss economy. Scheduled for release are the retails sales report and SECO sentiment survey. The unique view of consumers’ and investors’ perception of economy activity could guide growth forecasts; but the Swiss franc will undoubtedly see a greater reaction to risk considerations. Nevertheless, with inflation pressures starting to ease, the labor markets beginning to deteriorate, and consumers likely to cut back on spending, it may only be a matter of time before the Swiss National Bank starts considering cutting interest rates.

Canadian Docket Produces Surprising Volatility But No Breakout

For the past six months, the USDCAD has been frustratingly range bound leaving traders to patiently wait for confirmation that this is either a long-term bottom or an extended breather in the bigger downtrend. Typically, the congestion is no problem for speculative traders who perform well in range trading; but the threat of volatility and a big break out have grown exceedingly high over the past few weeks as the pair has worked its way into a narrow wedge that is positioned symbolically just above parity. This past week’s economic and exogenous event risk certainly held the potential to trigger the long-awaited breakout. From outside the economic docket, global financial headlines were riddled with new record highs in crude – which breached $126/barrel in Friday’s session. If there were ever a time for the USDCAD/crude correlation to shine, this would have been it. However, despite the urgency and considerable publicity behind the dramatic rise in energy prices, the correlation remained absent.

The economic docket would similarly have its chance to move the market; and ultimately it did produce considerable heat though no fire. Looking back over the lineup of releases, the data covered virtually the entire economy. Taking a look into the housing market, building permits for the month of April and housing starts for April would both disappoint. Though Canada’s housing sector isn’t suffering from the same level of crunch that the US and UK are suffering, tough lending conditions have nonetheless crossed the boarder. Plans to build droped to a 13-month low while actual starts set a four-month trough. As the week progressed the data began to improve. The Ivey business activity report for April reported a smaller than expected contraction. However, a closer look at the breakdown revealed that deliveries actually contracted and the prices component accounted for a bulk of the headline rise by hitting 80.7 (50 is the expand/contract level). The top market moving employment data was similarly mixed. Employers added 19,200 jobs last month – more than expected – though few of them were in the private sector. What’s more, the jobless rate noted higher for a second month to 6.1 percent. Finally, the trade report was the least marred figure. Growing unexpectedly to a 10-month high, the C$5.5 billion surplus was buoyed by expensive commodities.

Looking to the coming trading week, the potential for a major breakout from the fundamental docket is significantly lower than what it was last week. In fact, there are only a few economic indicators scheduled for release; and each will likely be treated as a secondary or lagging report. The new home inflation index for March will bow to the previously released yet more timely starts and permits figures as pricing is not as much as a concern as demand for the strong economy. The second indicator is the factory shipments figure for March. With the trade figure reporting a 1.6 percent rise in exports and the Ivey performing better than expected, an upside surprise may be in store.

RBA On Hold But the Bias Remains Bullish

A substantial flare-up in Aussie dollar volatility came with Tuesday’s interest rate decision. The Reserve Bank of Australia opted to keep interest rates at a record 7.25% today. The move was widely expected by the market. Governor Glenn Stevens called for a need to slow down the pace of economic growth to tame inflation. Stevens further noted that while tightening conditions in international and domestic credit markets have helped to curb demand, "the rise in Australia’s terms of trade currently occurring, which is larger than had been expected a couple of months ago, will work in the opposite direction." That statement speaks directly to Australia's mining industry as it enjoys record-high commodity prices and seemingly insatiable Chinese demand. Expansion in this sector has driven unemployment to record lows, bolstered disposable income, and spurred the economy to continue to expand. Without a clear picture on whether the global slowdown and dearer credit will overwhelm the impact of the commodity rally and moderate inflation, the RBA will retain rates as they are. The bank continues to believe that the signs of slowdown in recent Australian fundamental data will continue to put the brakes on the economy, proving its "substantial" monetary tightening up to this point is enough to put a lid on price growth. In a hawkish concluding statement, Stevens warned that "should demand not slow as expected or should expectations of high ongoing inflation begin to affect wage and price setting, that outlook would need to be reviewed." Seemingly disappointed that rates had not been raised in spite of persistent inflationary pressure, traders broadly sold the Aussie following the announcement. The decline was short-lived however, as Thursday’s jobs data surprised profoundly to the upside. The release showed that the Australian economy added 25.4k jobs in April, soundly beating expectations of a mere 10k increase. The tight labor market has been one of the main factors bidding up inflation, and traders bought the Aussie on expectations that persistent price growth would force the policy marker’s hand to raise interest rates next time around. Friday’s Quarterly Monetary Policy Statement from the Reserve Bank passed with little fanfare as it largely mirrored everything that Glenn Stevens noted following the interest rates decision just three days earlier.

The week ahead should prove to be substantially tamer as the calendar carries very little significant event risk. Tuesday will bring April’s NAB Business Confidence report. Last month, the metric fell to -4.0 as firms signaled they were feeling the pressure from record-high borrowing costs. More of the same is likely going forward as the RBA’s aggressive tightening campaign works through the broad economy. The week is rounded out on Wednesday with May’s Westpac Consumer Confidence and the Wage Cost Index for the first quarter. The latter is sure to rise as the labor force continues to be stretched to the limits. The former will give traders a timely on current conditions. Last month’s result showed a -1.3% decline, and this month will likely continue in the same direction. As if record-high borrowing costs are not enough, consumers have also been hit with astronomical growth in energy and other primary products. This acts like a tax, depressing disposable income and discouraging consumption. A slowing here would surely offer some relief to Glenn Stevens and the RBA, as it would seem monetary policy was working as intended. However, a strong number could prove extremely bullish for the Aussie as it could be added to the already growing list of reasons for why the RBA should raise interest rates again.

New Zealand Dollar Tumbles As Bollard’s Hawkish Support Fades

While the Australian dollar is holding tenaciously to its recent record highs, the kiwi seems to have bowed to the reality that it was perhaps exceedingly overbought. The high-yielding NZDUSD extended its two month old falling trend channel by tumbling nearly 300 points from its intraweek high and setting a three-and-a-half month low in the process. Such a profound divergence between the kiwi and Aussie dollars clearly reveals a the waning influence that risk trends have over the broad market. However, in the absence of a major driver, there is always something there to fill the gap – data.

This past week’s economic calendar was only lightly populated, but the few indicators that were up to bat were a few of economy’s most market moving indicators. By far the most prominent piece of data to cross the wires was the employment data. It is the case for most economies that jobs figures are among the top moving indicators; but the New Zealand report takes it a step further in that it is released only once a month. According to the government’s statistics, the unemployment rate rose more quickly than expected to 3.6 percent – a second increase from the multi-decade low set just a while ago. The truly shocking statistic from this report however was the change itself which revealed a 29,000-person or 1.3 percent drop in jobs – the biggest decline in 19 years! The data was clearly disappointing as NZDUSD plummeted 100 points in minutes and during one of the most illiquid times of the trading day. The remaining data for the week was periphery to the jobs number. First quarter labor cost growth cooled to a year-low 0.7 percent while the average hourly earnings over the same period actually accelerated modestly to 1.1 percent.

On net, last week’s data was a direct contradiction to the RBNZ’s persistent hawkishness on monetary policy. Looking back to the end of the policy authority’s string of hikes through the summer of last year, the Governor Bollard made it blatantly clear that he was specifically watching stifling consumer spending and housing market strength for its influence on the long-term inflation outlook. Clearly, the plummet in employment growth will impact spending and home purchases. However, just to further confirm the sensibility of keeping rates elevated, next week’s calendar is inundated with rate-sensitive indicators. The consumer will be weighed by March and first quarter retail sales activity – which doesn’t look promising considering the drop in employment and sharp rise in costs for necessary goods like gasoline and food. For the housing sector, the QC house price and REINZ sales reports will take a good measure of overall demand. Then, the sensitive business sector will show weather its first contraction in two years with March’s reading is not just a one off with the NZ PMI figure. Finally, we will see the forward looking factory inflation report for the first quarter, which may cloud the previously released rise in the CPI gauge.

Boris Schlossberg is a Senior Currency Strategist at FXCM.