Can the Dollar Sustain Its Momentum Next Week?

Since the beginning of this week, the Euro has fallen more than 500 pips against the US dollar, its biggest weekly gain in 3 years. The prospect of a rate hike by the Federal Reserve in August and/or September as well as key event risks over the next 48 hours has currency traders rushing out of Euros. This morning, headline consumer prices grew by a more than expected 0.6 percent, driving the annualized pace of growth to 4.2 percent. Surprisingly enough, the rise in core prices has been relatively tepid which indicates that higher food and energy prices continue to be the primary contributors to inflationary pressures. These numbers validate the Fed’s need to be hawkish and support the case for a rate hike before the end of the year. However with such a spectacular move this week, the big question on everyone’s mind is whether the currency’s momentum can be sustained in the coming week. As indicated by the sharp drop in consumer confidence, vulnerabilities still exist in the US economy. According to the University of Michigan, consumer confidence for the month of June fell to the lowest level in 28 years. The sustainability of a turn in the US dollar will be largely dependent upon the outcome of this weekend’s G8 Finance Ministers’ meeting. There has been a lot of back and forth reports from “official sources” on whether the group will talk tough on currencies, keeping alive the threat of intervention. If a comment is made, it won’t be about the Asian currencies this time around and instead will be about supporting the US dollar, which would in turn trigger a sharp continuation rally. If currencies are not mentioned officially, the dollar could give back some of its gains, but that should not stifle the currency’s recent uptrend. The economic calendar next week is light with only moderately market moving reports due for release. This includes producer prices, the current account, the Treasury International Capital report, housing starts, building permits, industrial production, leading indicators along with the Philadelphia Fed and Empire State manufacturing surveys. Meanwhile there are also a few Fed speeches on the docket who will most likely verbally confirm the central bank’s hawkish monetary policy bias.

Euro Hit by Ireland’s Rejection of the Lisbon Treaty

The Euro came under additional selling pressure in the early European trading session when it became clear that Irish voters would reject the Lisbon Treaty. As the European Union’s second attempt at a constitutional treaty, in some ways it deals a significant blow to the EU but in some ways, it does not. Recall what happened in 2005 when the French and the Dutch rejected the proposed EU Constitution Treaty. The Euro weakened, there was a lot of panic and fear about the viability of the single currency but eventually, the Euro erased all of its gains and then some when traders realized that the single currency is here to stay. The same can be said this time around. The EU Constitution is at risk and not the European Monetary Union. The EU can still function under its existing agreements and with over 50 percent of all member states having already ratified the treaty (a unanimous vote was needed for it to passed), France’s Europe Minister believes that a separate legal agreement will be arranged with Ireland so that a no vote by one country does not hold hostage the 26 other member states, assuming that all of the other countries ratify the treaty of course. Therefore the impact of the Irish vote on the Lisbon Treaty should be limited. In the week ahead, we look forward to Eurozone consumer prices, the German ZEW survey and producer prices. Switzerland also has an interest rate decision and a small minority expects interest rates to be increased to 3.00%.

British Pound Held Back By the Dollar

The British pound has strengthened against all of the major currencies except for the US dollar which indicates that the strength of the greenback is the primary reason for the GBP/USD’s drop towards 3 month lows. With only secondary releases due from the US next week, UK economic data should return to the forefront and drive the fluctuations in the British pound. Consumer prices and retail sales are expected along with the minutes from the most recent monetary policy meeting. We believe most of these reports will be pound bullish as inflationary pressures in the UK continue to grow.

Canada is in the Limelight Next Week, New Zealand Retail Sales Beat Expectations

Despite stronger economic data, the Canadian and New Zealand dollars weakened while the Australian dollar strengthened. In Canada, manufacturing shipments increased a whopping 2 percent in April, compared to the market’s call for a 0.4 percent drop. New Zealand retail sales also rose for the first time in 3 months by 1 percent thanks to higher spending on cars and tires. Australia on the other hand had no economic data but RBA Governor Stevens did warn that the current level of interest rates, which is at a 12 year high, is essential to restrain inflation. In the week ahead, the Canadian dollar is one of the main focuses of the currency market as consumer prices, leading indicators and retail sales are due for release. New Zealand only has service sector PMI while Australia has the minutes from this month’s RBA meeting and leading indicators due for release.

Japanese Yen Closing in on 4-Month Low

The Japanese Yen is closing in on its 4 month low against the greenback. The Bank of Japan left interest rates unchanged at 0.50 percent last night, which was right in line with the market’s expectations. Economic data was mixed with the stronger industrial production report offset by another decline in consumer confidence. Sentiment in Japan has fallen to a 6 year low as consumers face rising prices and a softening labor market. Therefore heed BoJ Governor Shirakawa’s warning that there is a higher risk that growth will continue to slow.

Kathy Lien is the Chief Currency Strategist at FXCM.