Dollar Ambushed by Weak Jobs and Strong Trichet

What a rollercoaster week for the US dollar! On Tuesday Ben Bernanke surprised greenback bears by producing one of the most overtly pro-dollar speeches by any Fed chairman in a very long time. On Thursday, his ECB counterpart Jean Claude Trichet surprised euro shorts by hinting that the central bank may raise rates next month. And on Friday everyone was shocked by the massive rise in the unemployment rate which spiked from 5.1% to 5.5% in one month. The net result - a complete turnaround for dollar's fortunes. The EURUSD which had traded as low as 1.5363 rallied to a high of 1.5703 in the wake of Friday's news.

The sharp rise in unemployment is likely to have a very negative impact on the psyche of the US consumer. While few people in US pay much attention to the intricacies of BLS accounting, most are keenly aware of the direction in the unemployment rate and Friday's report makes clear that it is moving in the wrong direction. As we noted in our post NFP analysis, "The next key data point for the US economy will be Retail Sales due Thursday June 12th at 12:30 GMT. Given the fact that employment has suffered its fifth consecutive month of losses, the US consumer is likely to retrench spending. For the time being sentiment is heavily skewed in euro's favor, especially after yesterday uber-hawkish comments by ECB President Jean Claude Trichet. If next week's economic data proves as disappointing as today's NFP – the EURUSD may mount another challenge on its recent record highs. "

The one bright spot on the US calendar may be the Trade Balance data. Although it is forecast to print worse than last month, the favorable exchange rate could create an upside surprise in both exports and imports, but the help to the greenback is likely to be minimal as fears of a much more severe downturn in the US economy will now grip the market.

Euro Will Have To Break Record Highs On Rate Expectations Alone

The euro rallied right into the close last week as strong words from ECB officials left the euro one of the few major currencies looking at further rate hikes in a world of falling interest rates. Looking at an intraday-chart, the results of the ECB’s rate decision and commentary were unmistakable – whether you are a fundamental or technical trader. Last Thursday, the European policy authority announced it would not change rates in June – in line with expectations. However, President Trichet’s address to the market was anything but predictable. With indicators of growth cooling and credit problems still lingering, many market participants were expecting more dovish rhetoric, or at best an unchanged statement. Instead, the central banker said the group was in a state of “high alert” over inflation with 2008 CPI forecasts revised from 2.6.-3.2 percent to 3.2-3.6 percent. Packing more of a punch though was the loaded remarks that the policy group “could decide to move [its] rates by a small amount” at their July 3rd meeting. And, to banish any doubt of an impending hike, ECB Governing Council member Axel Weber said the financial markets, which were pricing in a rate boost, understood the message; and the policy group would “follow words with action.”

Looking out at the week ahead, euro traders will receive few indicators that could alter the outlook for interest rates. Growth trends may come under scrutiny though Trichet has made it more than clear that the bank is focused solely on inflation. On deck Monday, the German trade balance figure for April is expected to slip from 16.7 billion to 15.6 billion euros. Such a decline would highlight not only faltering international demand for European goods; but it would also reflect the burden of a record high euro – a concern that will no doubt return to central bank rhetoric should the currency continue to rally on rate speculation. Later in the week, the aggregate Euro-Zone industrial production number figure for April will measure the business community’s tolerance for record raw material prices and tempered demand both domestic and foreign. Finally, the aggregate employment figure for the first quarter will round out the light week. With the jobless rate holding at a record low through the period, this figure is likely to improve.

On balance, the scheduled event risk ahead certainly doesn’t measure up to the virtual assurance of a July rate hike. Therefore, watch for the market to take advantage of weakness in cross data as rate expectations diverge even further. What’s more, typically overlooked remarks by ECB members will no doubt take on a new role as the market tries to discern how many hawkish voters there will be in July.

Yen Finds Support As Risk Aversion Returns On Weak U.S. Jobs

The Yen started the week on a strong note as risk aversion was swept into the markets on the back of renewed subprime concerns. A profit warning by U.K. lender Bradford and Bingsley, the ouster of Wachovia and Washington Mutual’s CEO’s and renewed concerns on the solvency of Lehman Brothers would spark fear that another round of fallout from the financial crisis was coming. However, Yen bulls would be derailed by Fed chairman Ben Bernanke when he spoke in Spain. The central bank head confirmed that the MPC has ended its easing policy and was now focused on price stability and the effects of a weak dollar on rising inflation. The comments saw the dollar rally across all major currencies as the possibility of a rate hike or other intervening actions from the Fed increased. It looked like the USDJPY was going to remain above the 106 price level for the first time since February 28, until the U.S. employment report was released on Friday. A fifth month of job losses and unemployment rising to the highest level in more than two decades would see the pair fall over 100 points.

The Japanese economic docket is full of significant indicators and a BoJ rate decision, but they may have little influence over the Yen giving the current risk winds. However, expected improvements in machine orders and GDP will be encouraging, but not enough to influence the central bank in its policy decision. The MPC will most likely leave rates unchanged at 0.50% like it has done since February 2007. However, Governor Shirakawa warned when it was his turn to speak in Spain that `If this monetary accommodation is maintained for long, while downside risks subside, it might accentuate future significant swings in the economy by, for example, encouraging excessive risk taking.'' Therefore, it appears that the MPC may look to raise rate as soon as they perceive the economy to be bottoming. A hawkish Shirakawa following the rate decision may be enough to present significant event risk for the pair. Meanwhile, U.S. retail sales may be the most impactful economic release, as the expected improvement may usher in renewed risk appetitive.

British Pound Could Continue To Climb On Inflation Concerns

The British pound spent the majority of the week falling toward 1.9500 as UK economic data was generally disappointing, but the lack of a rate cut by the Bank of England helped the currency rebound on Thursday and Friday. Looking at the data on hand over the past week, we saw signs that the UK housing, manufacturing, and services sectors are taking a heavy hit, as BOE mortgage approvals slumped to 58,000 in April – the lowest since record keeping began in 1999 – while the manufacturing purchasing managers’ index (PMI) for the UK tumbled to a reading of 50 from 51, indicating that growth in the sector has stalled. Finally, UK services PMI unexpectedly fell below 50 to 49.8 in May, signaling contraction in the sector.

However, perhaps the most daunting piece of news was an announcement from Bradford & Bingley, the UK's largest lender to landlords. B&B appears to be in trouble financially, as they said they would sell shares at a 33 percent discount amidst deteriorating housing market conditions. The news led Fitch Ratings to cut its long-term default rating and placed the firm on “watch negative,” and while B&B’s Chairman has affirmed that the company remains “well capitalized,” it is obvious that the UK financial markets are far from stable. Furthermore, on Friday, B&B said they were increase mortgage rates for new customers, citing the rising cost of funding as counterparty risk remains high. Indeed, the firm is likely also looking to cut back on their exposure to property buyers, and raising rates will effectively weigh on demand. The BOE has already stated that there are significant risks associated with mortgage-backed securities in the UK, particularly commercial ones, and if property values continue to plummet as they have in the US, the global credit markets may be hit by yet another wave of severe tightening. Nevertheless, because inflation in the UK economy is accelerating and is anticipated to only get worse, the BOE has very little room to maneuver when it comes to monetary policy, which is why the MPC left rates steady at 5.00 percent.

Looking ahead to this week, UK data is likely to continue reflecting weakness in the housing and manufacturing sectors, as well as the labor markets. In fact, RICS house prices are anticipated to reflect continued declines in home values, industrial output growth is forecasted to stall, and most workers are anticipated to claim jobless benefits. However, there’s something to be said for building price pressures in the UK economy, as it is the main reason why the BOE did not cut rates last week, and the release of the producer price index (PPI) is likely to highlight this. Indeed, input and output prices are likely to rocket higher at the factory gate, which will underpin the BOE’s concerns about upside inflation risks and could lead the British pound to start this week on a strong note.

Swiss Franc Surges As Yield Gap With Dollar Expected To Widen

The Swiss franc has been particularly strong against the U.S. dollar on evidence that the downside risks for the U.S. economy are somewhat stronger. Indeed, the USD/CHF lost nearly 2 percent over the last five days, trading from an open of 1.0415 on Monday to a low of 1.0185 reached on Fridays session. The franc has also traded well against the euro and sterling since the recent spike in volatility across the world’s financial markets has prompted many investors to close out carry trades. More specifically, the franc appreciated 1.65 percent against the sterling and 30 bps against the euro.

Despite the current turmoil on the U.S. equity markets, the Swiss economy continues to grow but at a slower pace. Yet, the continued high price of oil and the high degree of resource utilization are all important factors having an inflationary effect in the Swiss economy. In fact, this week, the Federal Statistics Office in Neuchatel, reported that consumer prices in Switzerland accelerated more than economists forecast to the fastest pace in almost 15 years. The Swiss National Bank is closely monitoring the consumer price index and any positive development in the current financial markets condition could prompt the SNB to raise rates one more time.

Looking ahead to the next week, the most important indicator to be released is the Unemployment Rate which is expected to decrease to 2.5 percent from 2.6 percent in the previous month. Spending among consumers has been boosted by the current situation on the Swiss labor market and traders will be watching for any sign of weakness. In April, the Swiss jobless rate unexpectedly rose for the first time in more than four years.

Canadian Dollar’s Lack Of Rally On Record Oil Raises Concerns

The Canadian dollar topped the majors for volatility last week. Making up for a virtually calendar economic calendar through the first half of the week, declining crude prices helped to boost USDCAD more than 230 point through Wednesday’s close. Oddly enough, when the fundamental fireworks began in earnest Thursday, the pair would invariably lose its momentum. The late economic start to the week began with the April building permits report and May Ivey Purchasing Managers Index. Applications for housing starts jumped 14.5 percent – the most in 11 months – though optimism was restrained by the fact that the entire gain was made up in multi-family homes and not the single-family units that more closely reflect the health of the consumer. The Ivey’s business activity report came with similar caveats. Though the headline reading also hit an 11 month high, it was mostly due to the most oppressive inflation component reading on record. In the end, these numbers would fall short of the market-moving potential that the monthly employment change held. However, for all its clout, the indicator would come nearly in line with expectations with its 8,400 improvement. On the other hand, details showed that more coveted full-time jobs actually fell by 32,200.

So given the disappointing set of Canadian indicators that crossed the wires last week, why was USDCAD unable to maintain its upward trajectory? Technical traders would say that spot had reached the boundaries of its mature range. Perhaps a little more aggressive assertions came from the fundamental crowd. Coming across the wires shortly after the Canadian labor report, the US NFPs were a clear disappointment for dollar traders as the currency was sold liberally across the market – a neutralizing effect on the loonie’s descent. What’s more crude prices were turned onto a two-session rally that would take the commodity on a 13 percent rally to a new record high of $138.54/bbl. However, it is unusual that such momentum and fresh record highs would not generate more activity in the Canadian dollar. Perhaps this is a sign that the market is no longer looking for reasons to buy the loonie; but is now seeking reasons to buy USDCAD.

If the market is specifically seeking reasons to sell the Canadian dollar, they may find it on this week’s economic docket. Amid a few modest market movers, top event risk is clearly the Bank of Canada’s rate decision. With both headline and core inflation well below the central bank’s target the policy group is expected to forestall declines in economic activity by lowering the benchmark lending rate by a quarter-percent to 2.75 percent. This would be a more modest easing in comparison to the two previous 50bp cuts; but the easing would nonetheless diminish the currency’s yield advantage. Besides this rate decision, housing starts for May and the trade balance for April could generate healthy price action as economists try to gauge the health of the economy’s two key components of growth – consumer spending and exports.

AUD - Exporters and Consumers Duel to Guide Aussie Interest Rates

Last week’s barrage of Australian data releases clearly revealed the trajectory of the antipodean economy as it transitions from the first into the second quarter. Q1 Current Account and GDP figures followed predictable patterns rooted in the swiftly expanding mining export sector. Driven to meet Chinese demand for coal and iron ore, mining companies have aggressively expanded labor and capital capacity. This pushed up Q1 business investment 1.5% (versus 0.8% in the preceding period) while additional hiring boosted disposable incomes and spurred consumption. Not surprisingly, such buoyant activity moved GDP to rise, surpassing expectations to print at 0.6% versus 0.3% forecast. It also helped to widen the trade shortfall, leaving a gaping hole of –A$19492 million as the aforementioned increase in consumption saw a rise in demand for imported goods. The trade shortfall was exacerbated by unfavorable weather conditions, with heavy rainfall bringing floods that disrupted shipping and reduced export volumes.

The second quarter is shaping up to be a stark departure from the first, with rising commodity prices (for food and petrol in particular) and high interest rates outweighing the tight labor market to subdue consumption. As much was evident in April’s Retail Sales report, which saw contraction of -0.2% from an equivalent expansion in March. The trade situation has improved as import demand followed overall consumption to drop -2% in April while exports of coal and iron ore got a green light from easing weather conditions, the former rising a whopping 23%. Overall, April’s Trade Balance figures saw the deficit shrink sharply to –A$957 million from –A$2548 million in March.

Developing second quarter trends are welcome news for RBA policymakers as they try to contain the mining boom’s upward pressure on inflation. The slowdown at home serves the RBA’s policy objectives and helps to validate their assertion that borrowing costs at 7.25% are “substantial” enough to achieve price stability. To that effect, Governor Glenn Stevens kept rates on hold for the fourth consecutive month in an announcement Tuesday. That said, the bank may find itself in a tough position at their next meeting as export growth throws more fuel on the fire and equates taming price pressure with crushing the domestic economy.

Looking ahead, a quiet week will give the markets a chance to digest last week’s developments. Tuesday brings June’s Westpac Consumer Confidence, a reading sure to reflect a consumer buckling under the weight of high borrowing costs and commodity prices. Wednesday’s Employment report for May will reveal if the current deterioration in the domestic economic climate has eased any of the tightness in the labor market. If so, Glenn Stevens and company are sure to breathe a bit easier going into July’s monetary policy meeting. If not, the RBA may be forced to act against wages’ persistence in bidding up the price level by raising rates again.

NZD – New Zealand Signals First Rate Cuts Since 2003

New Zealand’s calendar was far lighter in quantity but no less profound in meaning compared than its antipodean neighbor. While Tuesday’s rebound in May’s Commodity Price Index (1% versus -0.3% in April) passed with little fanfare, the real news lurked in Wednesday’s RBNZ rate decision.

The Reserve Bank validated market expectations, confirming interest rates would remain at the record 8.25% level. Bank Governor Alan Bollard justified the action with a prediction that inflation would reach as high as 4.7% in the third quarter, noting that "although much of this reflects higher food and energy prices, underlying inflation pressure also remains persistent." Bollard made a direct reference to stagflation, saying that the combination of price pressure from booming commodities coupled with a global credit crisis and slumping housing markets is "producing a challenging environment of weak activity and high inflation." The bank slashed growth expectations from its previous assessment, noting GDP expansion would be next to nil this year followed by a modest recovery in 2009.

That said, Bollard was optimistic in the medium term inflation outlook, saying that the RBNZ still expects an easing in input costs and the global slowdown to bring prices into the bank's comfort range. In fact, Bollard was so confident that prices would come down that he expected to be able to cut rates by the end of this year, a marked departure from any RBNZ policy statement in recent memory. Specifically, the last time the RBNZ cut rates was in September of 2003. The New Zealand dollar reacted strongly to profoundly dovish tone of the announcement, plunging 86 pips in the first ten minutes following the release.

This week’s calendar is likely to advance the strongly bearish bias already imbedded in the Kiwi dollar. The single market-moving item on the docket comes Thursday with April’s Retail Sales report. A decline of -1.2% in March out the metric at the lowest level since 1997, with precious little to support expectations of an upside surprise this time around.

Boris Schlossberg is a Senior Currency Strategist at FXCM.