Dollar Tumbles After The Fed’s Neutral Turn Surprises No One

The dollar was on the chopping block last week even though the Fed issued its most hawkish minutes in over a year and the economic calendar produced few serious hurdles in a docket that was lacking top market moving indicators. Looking back over the period, it was clear that the FOMC minutes for the April policy meeting carried the greatest fundamental weight. Not only did this statement clue the market into why the group decided to deliver its smallest rate cut this year; but it also included their quarterly growth and inflation forecasts. The outlook for growth was certainly a bearish distraction with a projection for unemployment to “increase significantly” and noting that there were was “little indication” that the housing recession was near its end. Ultimately, the Board revised its growth outlook for the second half of the year from 1.3-2.0 percent to 0.3–1.2 percent and deemed it noteworthy that ‘many’ officials believed GDP actually contracted through the first half. All this considered though the minutes would actually have a hawkish bias in the end. Turning their attention from the short-term cooling in growth and the long-term implications of building inflation, the group noted risks were “more closely balanced.” What’s more, ‘most’ of the members viewed the modest 25bp cut on April 30th a close call. No doubt, market took this to mean the central bank would hold in June; but this was merely confirmation for traders that were already pricing in a 90 percent probability that that was the outcome anyway.

Outside of the Fed’s wrap up, the economic calendar was printing data that merely confirmed the unfavorable outlook for growth and inflation. The core PPI figure for April accelerated to a 17-year high, yet the market had already spent its inflation bullets on previous week’s CPI numbers. For growth, April’s Leading Indicators unexpectedly rose for the second month in seven, but the breakdown offered more than one reason to be skeptical about the headline’s outlook.

For the week ahead, the dollar have to avoid retesting record lows on a foreshortened and relatively light economic listing. After the extended Memorial Day weekend, we’ll get a round of housing data (S&P/CS and New Home Sales), the Conference Board’s consumer sentiment gauge and durable goods. These numbers aside though, Thursday’s 1Q GDP revision may prove to surprise market mover for the week as a boost in consumer spending and trade numbers may give the economy a little more breathing room for the second quarter.

Euro May Retest 1.60 If German Data Meets Expectations

The euro regained its balance this past week, though European fundamentals couldn’t claim all the credit. With a relatively light (and certainly mixed) economic docket, the currency market’s most liquid major was finding its strength from the same source as every other major pairing – dollar weakness. Nonetheless, there were some surprising releases over the period that will certainly alter growth trends and policy decisions in the weeks and months ahead. Supporting Trichet’s ongoing fight against inflation, the upstream German PPI numbers accelerated to a new two year high. In turn, however, growth projections were hammered by the closely watched PMI business activity indicators which slipped to a five-year low. These more timely reading counters the strong German and EZ GDP figures we have seen recently; so it will be important to see if and how the ECB members address this data going forward.

Moving from a rather empty calendar to one that is fully stocked, the euro may find that fundamental currents may be too strong to overcome even if the dollar is on the lam. Most of the economic fodder will be fed through the German wires. The final readings on the first quarter GDP report will confirm whether Europe’s largest economy truly did expand at its fastest clip in 12 years. From there, the data will be fresh. The GfK Consumer Confidence reading will round out the three sentiment reports with an expected slip that would follow investors’ pessimism rather than business leaders optimism – though the expected 25,000-person drop in unemployment due Thursday would suggest otherwise. Putting Germans’ confidence to the test, the retail sales report is expected to put up a solid rebound from March’s 1.9 percent drop in spending. And, just to make sure the policy outlook is evenly balance for the following week’s ECB rate decision, the Germany CPI figures are scheduled for release on Wednesday without a set time. The forecasted rebound to a 2.8 percent, year-over-year pace would offset April’s surprise drop to 2.4 percent and restore the market’s portrayal of a ECB President Trichet as a restrained hawk.

Fundamentals Join The Mix With Risk In Deciding Yen Direction

The BoJ unanimously voted to keep their benchmark interest rate unchanged as expected at 0.50%, as growth concerns remain. Yet, the Tertiary index, which measures Japanese demand for services rose 0.3% in March from a decline of 1.6% the month prior. Consumers increased their spending on leisure activities like golf and the movies, although expectations have increased that rising inflation will curb demand going forward. Record setting oil prices saw equities sell off and take the USDJPY with it for most of the week. Although, oil eased a bit providing dollar support, yen bulls would eventually erase those gains as equities ended lower on U.S. housing concerns.

BoJ Governor Masaaki Shirakawa said on Friday that the central bank could not predict the course of monetary policy as it measured the downside risks of slowing growth against the upside risks of a decade high level of inflation. The central bank head maintains that the MPC will have a fluid monetary policy going forward. Yet, with interest rates at 0.50% their isn’t much room to cut and the preference of the BoJ is not to revert back to a 0% interest rate as in 2000-2006, when it brought excesses in employment , capacity and debt.

Considering that it may take a monumental change in inflation and or growth to evoke a rate change from the central bank, fundamental data may not have much sway over the Yen for sometime. Ultimately risk appetite will again control the reins as the low yielding currency may benefit this upcoming week as risk aversion is gaining momentum. The relief from the belief that the credit crisis is over is giving way to the concern over its long lasting impact on the global economy. Additionally, rising oil and food prices continue to sap consumers purchasing power and diminishing the global growth outlook. Nevertheless, upcoming consumption, manufacturing and inflation data bear watching as they may provide enough event risk to garner a trade.

Pound Finds Support As BoE Signals No Rate Cuts For The Year

The Pound made a steady climb throughout the week on the back of a hawkish BoE and better than expected fundamental data. A rebound in Rightmove house prices started the week, as sellers raised prices by 1.2%, as they were buoyed by the recent liquidity infusion by the BoE. However, industry leaders considered the higher prices foolish given the current economic and credit environment and that it may lead to increased inventories. Hawkish minutes from the central bank’s policy meeting would provide cable support and take the pair above the 1.9700 price level for the first time since May 6, when the PMI services report severely disappointed. Although retail sales declined 0.2% in April, the better than expected results would see the pair remain above 1.9750, which is now serving as short term support.

The BoE voted 8 to 1 to keep the benchmark rate unchanged at 5.00% at their May 8th policy meeting due to inflation concerns. Perennial dove David Blanchflower was the only dissenter calling for a quarter point cut, which was expected as he had publicly made statements calling for action to stem a U.K. recession. Inflation continues to remain a concern for the central bank as they believe that current record energy costs will filter through to consumer prices for the next twelve months. Governor Meryn King stated in the quarterly inflation report that he expects to have to write a letter of explanation to Chancellor Darling for several quarters as prices continue to grow above the 3% threshold. The majority recognized the significant growth risks to the economy from the declining housing market and property values, but felt that the slowdown was needed to rein in inflation and reach their 2% CPI target. The committee believes that further cuts would risk letting inflation get out of control and send the wrong signal to wage bargainers and companies. The expectation is that the MPC may not look to change interest rates in the near term, with futures pricing in an unchanged base rate through the end of the year.

This week will not present the amount of event risk as the week prior with Gfk consumer confidence, BBA loans for house purchase and CBI distributive trades all second tier indicators. Although last month’s sharp drop in the CBI report sparked bearish pound sentiment, the expected improvement shouldn’t have the same impact. Price movements this week may be steere4d by the U.S. calendar. We may see the pair settle back into the 1.9600-2.000 as both central banks are expected to keep rates in the near term.

Swiss Franc top G10 Currency on Pullback in Dow – Key Week Ahead

The Swiss Franc posted an impressive reversal on the week, as a downturn in global equity markets made the safe-haven currency the top G10 performer through Friday’s close. Marginally bullish economic data once again had little bearing on Swiss Franc price action, as the European currency showed itself far more sensitive to movements in key risky asset classes. That said, we saw domestic Producer and Import Price Index figures strongly above consensus forecasts—forcing further improvements in Swiss National Bank interest rate forecasts. The oft-quoted 2-year – 3-month money market yield spread now stands at its highest in nearly a year and reflects expectations that the SNB will gradually raise rates through the relevant time period. Rising inflationary pressures have effectively ruled out previous forecasts of SNB rate cuts, and the Franc has received a boost from said shifts in yields. It will nonetheless be important to watch developments in future economic data, and a busy week of Swiss economic event risk may go a long way in clarifying questions on the strength of the domestic economy.

Upcoming Swiss KOF Leading Indicator and Employment Level reports are likely to dominate CHF price action through short-term trading, as any surprises could shift sentiment on the current strength of the landlocked European economy. First up, the Employment report is forecast to show that the overall number of jobs grew by an impressive 2.6 percent through the first quarter of the year. Such a gain would reflect robust labor demand and clear proof of broader strength in the Swiss economy, but employment figures are typically seen as lagging indicators to expansion trends. A disappointment would certainly bode poorly for the market’s current assessment for the Swiss economy, but it is relatively unclear that a strong result would force noteworthy moves in the CHF. Forward-looking traders may have to wait until the following day’s KOF Swiss Leading Indicator report to force noteworthy moves across Swissie pairs. The leading coefficient is forecast to to pull back sharply through its most recent sampling period, but CHF bulls are clearly hoping for a better-than-expected print. Given a relatively improved Swiss ZEW business confidence survey, such hopes may not be completely unfounded. Otherwise, it will be very important to watch developments in global risky asset classes; the USDCHF and other pairs have moved nearly tick-for-tick with the US S&P 500 Index and its Volatility Index (VIX).

Canadian Dollar Gains as Crude Oil Hits Record Highs

Surging crude oil prices allowed the Canadian Dollar to continue its clear uptrend against its US namesake, with the Loonie forging fresh 2-month highs firmly above parity through Friday’s close. The NYMEX WTI Crude Oil contract set fresh record highs of $135.09 through late-week trade, dominating financial market flows and causing sharp moves in oil-linked forex pairs. The combination of higher oil and bullish economic data fueled the Canadian dollar’s ascent against the downtrodden Greenback. Indeed, a higher-than-expected Consumer Price Index report forced noteworthy corrections in Bank of Canada interest rate expectations and, by extension, the Canadian dollar. The spread between short-term and longer-term Canadian yields moved quickly into bullish territory, as markets now predict that the Bank of Canada’s short-term interest rate target will stay flat or rise through the coming two years. This is a marked turn from only several weeks ago when the yield curve was showing negative expectations, and the developments boost prospects for the relatively low-yielding Canadian dollar. Whether or not the Loonie can continue to gain will subsequently depend on shifts in sentiment on the Canadian economy, and the coming week’s key economic data will almost certainly clarify assessments on the current state of domestic expansion.

Canadian economic releases will be sparse in the week ahead, but a highly-anticipated Gross Domestic Product report due Friday may nonetheless force noteworthy volatility in the North American currency. Analysts’ forecasts run the full spectrum for the quarterly growth number, but it is generally assumed that the expansion rate will have fallen to its lowest levels in at least a year. Negative global growth prospects and a clear slowdown in the US economy are the main culprits behind below-trend expansion, but markets will pay close attention as to whether the highly trade-dependent economy can sustain positive growth rates in the face of slowing demand from abroad. Of note, we see that the similarly US trade-dependent Mexican economy held on to relatively robust growth rates through the first quarter despite the American slowdown. Though the Mexican and Canadian economies are hardly comparable, relatively bullish figures from the key trade partner raise hopes for the northern economy. Markets will pay close attention to the GDP release, while developments in oil prices will continue at the forefront in Canadian dollar trading markets.

Australian Dollar Hits Fresh 24-Year Highs On Hawkish RBA Minutes

The Australian dollar spent much of the week rocketing higher as gold broke above $900/oz and following the release of the minutes from the Reserve Bank of Australia’s most recent policy meeting, which reflected an unexpectedly hawkish bias among the bank’s board members. According to the minutes, the board spent “considerable time” debating the need for a rate increase, as there were concerns that monetary policy may not be “sufficiently restrictive” to cool inflation pressures. Nevertheless, the RBA ultimately decided to leave rates unchanged at 7.25 percent due to “the substantial tightening” in the credit markets and “uncertainty surrounding” the outlook for expansion and inflation. These will likely remain the primary factors that will prevent the RBA from raising rates throughout the rest of the year, but with inflation forecasted to hold above 4 percent “for much of 2008,” the RBA is highly unlikely to cut rates either. As a result, upside potential for the AUD/USD pair may linger in the long-term, and as Currency Analyst John Kicklighter discussed in a recent special report, the Australian dollar could reach parity with the US dollar.

Looking ahead to this week, the AUD/USD faces very little event risk as neither the Westpac Leading Index nor DEWR Skilled Vacancies tend to be big market movers for the Aussie. However, it will be crucial to keep on eye on two other factors: commodity prices and risk trends. First, commodities like gold rocketed higher last week, and such extensive moves tend to be followed by consolidations, if not outright corrections lower. Meanwhile, with Australian interest rates at a whopping 7.25 percent and US interest rates at a meager 2.00 percent, the AUD/USD pair is one of the prime carry trade pairs. As a result, traders should keep an eye on the status of the equity markets, as signs of a return to risk aversion could weigh heavily on AUD/USD.

NZD/USD - Will Tax Cuts Save the New Zealand Economy?

While the New Zealand dollar spent much of last week trending higher on the back of rising commodity prices, news of a tax cut sent NZD/USD rocketing over 100 points higher within an hour on Wednesday evening. Indeed, NZ Finance Minister Michael Cullen’s scheduled delivery of the 2008 budget proved to be the biggest market-mover of the week for the Kiwi dollar, as he announced NZ$10.6 billion in tax cuts over the next four years. Meanwhile, the April reading of the Performance of Services index tumbled below the 50 level to 48.9, signaling contraction in the sector. With the economy showing signs of distress as consumption, the housing market, and services sector all start to slow, the tax cut news helped to quell speculation that the Reserve Bank of New Zealand would be forced to cut rates this year from their record high of 8.25 percent.

Looking ahead to this week, traders should keep an eye on the trade balance for the month of April to see if foreign demand for NZ exports will be able to outpace resilient domestic demand for imports. Meanwhile, NZ business confidence is likely to turn increasingly pessimistic, as the strength of the New Zealand dollar and rocketing overhead costs are likely taking a toll on the sector. Overall, the risks are tilted very much to the downside for the New Zealand economy and thus, the Kiwi dollar, as record high interest rates begin have their intended cooling impact on expansion. Nevertheless, with the New Zealand government cutting interest rates, they may be inadvertently sparking a whole new source of inflation, which will only complicate monetary policy decisions by the RBNZ going forward.

Boris Schlossberg is a Senior Currency Strategist at FXCM.