Dollar – Another Test of 1.60?
For most of the week the EURUSD traded in a tight consolidation moving 50 points either side of 1.5500. In fact early Friday morning we noted that, “[a week from last Friday] the pair was trading at 1.5481 and as write this now five days later it is trading at the exact same spot. The currency markets are at standstill with 1.5500 representing the line of balance between the bulls and the bears. Neither camp has enough ammunition to push price away from that level. In EZ the data this week has shown surprising buoyancy in the GDP numbers forestalling any consideration of monetary easing for the time being, while in US the bounce in Retail Sales suggested that the consumer may be wounded but is still alive. Thus prices remain in equilibrium.”

The equilibrium was quickly broken by the horrid U of M consumer confidence numbers which dipped below 60 for the first time in 28 years as $4/gallon gasoline depressed consumer attitudes to levels not seen since the early days of Reagan administration. The key question going forward for currency market however is whether dour sentiment will translate into negative action causing US consumer spending to contract sharply. Certainly, stubbornly high oil prices offer no relief in sight. However, we believe that it is the job market that could deliver the knock out punch to the US consumer. Up until now consumer spending has been relatively resilient despite the challenging economic climate, in part due to soft, but not debilitating labor market conditions. However, if jobs losses skyrocket at the same time as gasoline remains above $4/gallon – that deadly combination will likely destroy whatever consumer demand is left, pushing US into a clear cut recession while driving the dollar back to its lows.

Next week the US data calendar is relatively sparse, so some of these macro economic questions may have to wait to be resolved until the month over. Aside from PPI which most market analysts expect to decline sharply, the one report that is likely to garner interest will be the Existing Housing release due on Friday. Although the housing sector is in a severe contraction with annual run rate now consistently below the important 5M unit mark, traders will once again look for any sign of stabilization and if they find it the greenback may get a small boost from the results.

Euro – No Rate Cuts in Sight
Both German and French GDP numbers posted blockbuster results this week with German Q1 GDP rising 2.5% vs. 1.8% projected while French growth increased 2.2% vs. 2.0% expected. The two main economies of the EZ contributed to a better overall number for the region which also printed at 2.2% vs. 1.9% forecast. The news cast doubt on any notion of a near term ECB rate cut, as Q1 growth proved far stronger than most analysts had forecast.

However GDP data by its very definition is backward looking and the more recent economic news from the EZ have not been nearly as impressive. In fact the latest reading from both manufacturing and services PMI surveys have signaled a significant deceleration of economic activity in the region in Q2. Yet the extent of the slowdown remains unclear to the market and this week’s ZEW and IFO survey may go a long way towards resolving the confusion. Both reports are expected to decline from the month prior, but if the market sees another worse than expected reading especially from the IFO, the euro will have a hard time making any headway, even if US data continues to deteriorate.

The ECB has been coasting on the tailwinds of steady economic growth and buoyant labor market demand. Nevertheless, if this weeks IFO prints another negative surprise like last month European monetary authorities will have to seriously reconsider their uncompromising hawkish stance. If on the other hand, the IFO data proves to be a non event, the euro could extend its rally as attention once again turns to deteriorating US fundamentals.

Japanese Yen – Risk Is Back But For How Long?
On Friday Japanese GDP surprised to the upside expanding at 0.8% versus 0.6% expected as growth from emerging markets offset the downtown in US demand, but the positive impact of the news was short lived, as other more forward looking data points suggested that growth in world’s second largest national economy is decelerating significantly. Japanese Industrial Production declined -3.4% vs. 3.1% forecast, while consumer confidence declined to 35.4 – the lowest reading in 4 years. Even the GDP report contained a measure of bad news as CAPEX fell precipitously declining -0.9% on a quarter over quarter basis which prompted Japanese Finance Minister Fukushiro Nukaga to express concern about the slowdown in capital spending. In short there is little reason to expect any change in Japanese monetary policy anytime soon given these lackluster results and this week’ s BOJ meeting is unlikely to produce any change.

With fundamentals having virtually no impact, the yen will continue to trade on risk assumption/risk aversion flows next week. Before Friday’s U of M Consumer data the pair hit the 105.00 figure, but the sharp decline in consumer sentiment spurred fresh speculation that the worst may not be over for the US economy. If that theme persists and US equities begin to slide USDJPY is likely to follow unwinding most of the gains achieved this week.

Pound Unchanged, Despite Rising Inflation And Hawkish BoE
Inflation was the story of the week for the U.K. as producer prices posted their sharpest gain ever recorded and consumer prices rose to the central banks threshold level of 3%- the highest since April 2002. The results led to the BoE issuing a significantly hawkish quarterly inflation report which signaled that the MPC may refrain from further rate cuts for the remainder of the year. This was in stark contrast to the prevailing expectation in the market, that a quarter point rate cut was forthcoming at the June policy meeting. The typical bullish sentiment failed to inspire traders, as the weighed the long-term implications of rising prices on the economy. A 95.1% decline in the RICS house price balance and a 7,200 increase in jobless claims underlined the ills of the housing sector and its broader impact on the economy. Although the inflation data provided support for the cable early in the week, the complete dour fundamental picture would leave the pair relatively unchanged by week’s end.

The acceleration of the deterioration of the housing sector over the past few weeks has prompted the government and Prime Minister Gordon Brown to announce the creation of a £200 million fund to purchase unsold homes. £100 million will go to shared equity schemes to all more first time buyers to purchase newly built homes. The separate measures have given the central bank confidence that the credit issues will improve, thus allowing them to focus on price stability. The country has seen inflation rise to 3%, which is the threshold which requires Governor King to write letters of explanation to Chancellor Darling. The MPC’s recent quarterly inflation report underlined their concerns, when central bank leader stated that he expects to write several letters over the next few quarters.

This week will make the third straight that the economic docket presented significant event risk for the pound. It will highlight all the areas of focus for traders including the housing sector, growth, domestic spending and the central banks inclination. Rightmove house prices and retail sales are expected to show that the housing continues to falter and consumer are withering from the headwinds. Despite the BoE’s recent hawkishness, the minutes from their policy meeting are expected to show a less than unanimous decision. The impact for the markets will come if there were more calls for a rate cut than David Blanchflower, which may fuel speculation that there still exists the possibility of a rate cut in the future. The pair has found major support at the 1.9400 price level and it may require significantly bearish fundamentals to see it break clearly below.

Swiss Franc Drops on Dow Rallies – Is Carry Trade Back?
The Swiss Franc finished the week slightly lower against the US dollar, as a noteworthy recovery in global risk sentiment encouraged traders to sell the low-yielding currencies. The US S&P 500 index traded to its highest levels of the calendar year, while its Volatility Index (VIX) fell to similar lows. Lackluster Swiss economic data only compounded CHF-selling pressure, and indeed the domestic currency was the second-worst performer among the G10 to round out the week’s trading. An ostensibly bullish Retail Sales report was actually quite disappointing; a headline 9.7 percent gain was entirely a function of an unusually large seasonal adjustment. Excluding said adjustment, Retail Sales actually produced a rather disappointing -2.5 percent monthly change and exacerbated fears of a domestic economic slowdown. It is subsequently unsurprising to note that traders increase bets that the Swiss National Bank would cut interest rates in 2008—forcing similar moves in the CHF.

Whether or not the Swissie will continue its slide will largely depend on outlook for global risky asset classes, as a relatively empty economic calendar promises little in the way of foreseeable volatility for the carry trade currency. Possible exceptions include Tuesday’s Producer and Import Price Index report as well as late-week Trade Balance results. Yet PPI figures are comparatively unlikely to cause a stir, as markets have already seen the much more market-moving Consumer Price Index release. It seems that traders are most likely to ignore the subsequent ZEW survey release, while Trade Balance figures seldom force major moves in the domestic currency. As such, it will be most important to watch for fresh developments in global equity indices and other relevant risky assets. Given the growing sense of calm across financial markets, many feel that the time is now right to re-enter previously profitable currency carry trades. Yet any disruptions in said improvement could just as easily force significant pullbacks in the global carry trade and force substantial Swiss Franc gains.

Canadian Dollar Pushing Its Range As Fundamentals Heavies Loom
While there was a broad push against the US dollar last week, the selling momentum was particularly meaningful for the long range-bound USDCAD. No other major pair has seen the level of congestion that the loonie-based cross has experienced over the past six months. A more expansive view of a USDCAD chart shows price action has been boxed in between range extremes at 1.0375 and 0.9700 since the sharp November reversal ran out of steam. However, more recently price action has had even less room to move as a downward sloping trend channel over the past two months has kept activity to a 250-point band. This has generated considerable pressure behind a potential breakout as hard technical levels are now starting to interfere with price action. Parity (1.0000) was the most recent level to run interference against the steady slope of the trend channel. This psychologically important and frequently tested pivot level was nearly overrun through the very end of the week as yet another slopped channel within the congestion pulled spot down to 0.9950.

Looking back over the fundamental influences on the pair last week, there were few pieces of event risk that could finally drive USDCAD to its much needed breakout. Aside from the few US indicators that weighed on the pair, crude was another underlying factor in the loonie’s steady advance. Crude on the NYMEX closed Friday’s session above $126/barrel for the first time on record. However, this extreme has so far failed to revive the tight correlation between the two assets some months ago. There was similarly little going on in the Canadian economic docket. Top event risk for the period was the New Home Price Index for March. The lagging report matched the consensus for a modest 0.2 percent advance for the month. From a broad fundamental perspective this data series confirms that the Canadian economy has so far avoided the housing crisis that has plagued the US and UK; but at the same time, it doesn’t garner much immediate enthusiasm for the Canadian currency. The same can be said about the manufacturing shipments report for the same month. The volatile indicator slipped more than expected, yet its importance has been superseded by the previously released trade balance and Ivey reports.

For the week ahead, the probability for a genuine breakout is much higher (especially if USDCAD holds close to support around 0.9950/1.00 for the release of major economic releases). There are a number of indicators scheduled through the period; but the greatest promise for volatility rests with the CPI and retail sales numbers due later in the week. The headline consumer inflation gauge is expected to hold steady at its 14-month low 1.4 percent clip, while the core figure holds its own four-year low 1.3 percent. No matter what happens to these figures, they will be fundamentally significant as BoC Governor Mark Carney had suggested just last month that he would lower interests again in June. On Thursday, retail sales is expected to report a significant recovery, yet with confidence souring, the risk is still to the downside.

Australian Dollar Reaches 24-Year High
The small helping of Australian data for last week did not leave the Australian dollar wanting for a catalyst as the pair rallied to levels unseen since the mid-1980s. To start the week, the National Australia Bank reveled that businesses were at their most pessimistic in April since September 2001 as their confidence index dropped to -8 from -4 in the preceding month. A negative reading means more survey respondents expect their prospects to deteriorate versus improve in the near term. The result supports assertions by Governor Glenn Stevens of the RBA that the economy is slowing. Stevens must surely have been pleased when Tuesday’s first quarter Wage Cost index printed at 0.9% versus the expected 1.1%. The result brings the annual pace of wage growth down to 4.1% from 4.2%. Wages have been a key contributor to inflationary pressure. Aggressive hiring in the mining industry servicing China’s insatiable demand for Australian coal and iron ore exports has brought unemployment to a record low. The scarcity of labor supply in the face of such robust demand has inflated wage growth, bidding up the overall price level. While further evidence is needed, the initial easing in the Wage Cost index suggests the RBA has been correct in calling current borrowing costs at 7.25% “substantial” enough to tame price growth. Technically speaking, we identified a Bearish Engulfing candlestick pattern in the Australian Dollar / US Dollar pairing early in the week and reckoned prices would drop to support above 0.9285 before another run to 0.9500 (see article). The pair validated our analysis, dipping lower to create the entry and then rallying to surpass our target and closing the week at 0.9543.

This week again offers little by way of significant economic data. The RBA’s level of transparency and the fact that their quarterly monetary policy review was published shortly following the latest rate decision is likely to make Monday’s release of the minutes from that meeting old news. Tuesday will arguably be the most interesting as traders will be treated to May’s Westpac Consumer Confidence metric. The release will provide a timely reading on how the consumer is shouldering the burden of record-high borrowing costs along with booming food and petrol prices. April saw the metric decline by -1.3% and with the overall fundamental picture largely the same as it was then, further decline is likely. Motor Vehicle Sales for April will be released shortly after, with anything shy of a sharp contraction being truly surprising. Last week saw drops in auto sales drag down retail activity metrics in both the US and New Zealand as fuel costs skyrocket, and Australia is certainly not immune. The week’s docket will clear by Wednesday with the release of May’s Consumer Inflation Expectation. This will be the first gauge of the price level since last week’s encouraging Wage Cost index and traders will look for a pattern to reveal itself.

Technicals Stall Kiwi Decline as Data Disappoints Again
Last week saw the precipitous fall of the New Zealand dollar find a short term bottom. The latest fundamental data can hardly be given credit, as most significant metrics released last week showed decline. The week began with April’s QV House Price Index. The metric showed house prices grew 4.3%, a steep decline from March’s 6.5%. This marks the eighth straight month of slower price growth as record-high interest rates depress demand. April’s Business NZ Purchasing Manager’s Index offered the only bit of good news for the week, rising from a reading of 48.7 in March register at 51.4 and above the 50 “boom-bust” level. Such optimism in manufacturing sector may stem from the forthcoming free trade agreement between New Zealand and China. Chinese demand has done wonders to spur growth in neighboring Australia and the easing of restrictions that the agreement promises could divert a good portion of business to New Zealand. Unfortunately for the island nation, the good news stopped here. Retail Sales declined three times more than expected, showing a drop of -1.2% in March. While the extent of the slowdown is certainly notable, the downward trajectory in the retail sector was to be expected. Confidence readings have slumped, and employment registered at 19-year lows. The RBNZ now treads in dangerous territory as it is apparently crushing the economy along the way to squeezing out inflationary pressure. Taming prices may prove elusive, as the global boom in energy and food continues pushing higher. Mirroring a pattern seen in US retail sales earlier in the week, car sales were the main culprit of the slump. Tellingly, excluding autos would have seen a drop of only -0.5%. Going further, excluding cars along with related purchases of gasoline and expenses on automotive repairs would have actually seen a rise of 0.2%. Underscoring this dynamic, Thursday saw prices for production inputs nearly double in the first quarter, rising to 2.3% from 1.3%. Prices for producer’s output rose to 1.8% from 1.5%. This is bad news indeed, as the speed of the rise in production costs is apparently outpacing the rise in the price of the finished product, making New Zealand firms on the whole inherently unprofitable.

The gloom in the fundamental picture did not seem to come as a surprise to the market, as traders have been pushing NZDUSD lower for several weeks now. The end of the week saw a bottoming driven largely by technical considerations. As we noted in the beginning of the week, “a heavy price congestion area lies above 0.7600, raising the chances that a support level will emerge in the coming days” (see article). With an unusually light calendar, technicals are likely to remain the primary drivers for this week’s price action. The only significant market-moving item on the docket will be Finance Minister Cullen’s presentation of the government’s 2008 budget on Wednesday. Plans for a dose of fiscal stimulus may somewhat ease the clearly bearish market bias towards the Kiwi dollar.

Boris Schlossberg is a Senior Currency Strategist at FXCM.