Big Week Ahead for the US Dollar

The US dollar continued to sell-off for the third consecutive trading as the Fed’s disappointment hangs over the market. Personal income and personal spending both increased more than expected thanks to stimulus rebate checks. However apparently the BEA included the tax rebates in the personal income calculation which means that it could easily reverse in the coming months. The PCE inflation numbers confirm the existence of high inflation pressures even though they were slightly weaker than the market expected. In the coming week, the dollar should remain weak. It will be a shortened trading week with US traders off for the Independence Day Holiday, but that does not mean that there will not be volatility. With non-farm payrolls, service and manufacturing sector ISM numbers due for release, expect some decent action in the US dollar. Based upon the recent layoff announcements and cutbacks by companies across the nation in response to higher energy prices, job losses will continue. Not only will non-farm payrolls drop for the sixth month in a row, but we believe that the market’s -55K forecast is overly optimistic. Although the Federal Reserve has grown more hawkish, with more than 1 month before the next FOMC meeting, currency traders know that nothing will happen between and now and then. Therefore the central focus will be on the comparative hawkishness of other central banks such as the European Central Bank and the Reserve Bank of Australia, who both have monetary policy meetings next week.

ECB to Raise Rates in July, but then What?

The European Central Bank has a monetary policy decision next week that stands to challenge the market moving potential of the US non-farm payrolls report. Due to the shortened trading week, NFPs will actually be released on Thursday instead of Friday, right around the time that ECB President Trichet begins his post meeting press conference. A quarter point rate hike has been completely discounted by the market but what traders haven’t figured out is what will happen next. ECB officials have tried to warn everyone that the July rate hike will be one-off, but judging from the recent price action in the Euro, it appears that currency traders are hoping for more. With inflation skyrocketing, Euro bulls hope that the ECB not only raise rates but hint that rates will be increased again before the end of the year. Although another tightening may not come in August, rates could rise in September or October. Before the ECB meeting, we are expecting consumer spending and employment numbers from Germany along with Eurozone producer prices.

British Pound On its Way to 2.0

The British pound rose to a 2 month high as the current account deficit narrowed from –GBP12.2B to –GBP8.4B in the first quarter. The improvement was hardly surprising given the better trade balance reports for the first three months of the year, but the detail of the report indicate that it was largely to due a decline in net overseas income. First quarter GDP was revised downwards due to weaker consumer spending and lower services output. These numbers are in line with the Bank of England’s projections for slower growth and are what the central bank hopes will bring down inflation. In the week ahead, housing market indicators, service and manufacturing PMI reports are due for release. Given the rebound in the CBI industrial trends survey, manufacturing conditions may have actually improved this month. Activity in the service sector on the other hand should deteriorate if consumer confidence does not hold up. Retail sales last month were strong, but the CBI distributive trades survey is still negative, pointing to underlying weakness. Either way, with the GBP/USD trading above 1.99, there is a strong chance that we will see a retest of 2.0.

Australian, New Zealand and Canadian Dollars Extend Gains

The Australian, New Zealand and Canadian dollars extended their gains against the greenback largely due to dollar weakness as both Australian and New Zealand economic data fell short of expectations. Australian quarterly wage agreements dropped from 3.8 to 3.7 while GDP growth in New Zealand contracted by 0.3 percent in the first quarter. Taking a look at the price action of these currencies, it is clear that the numbers seem to matter little to currency traders who are focused on dollar weakness. In the week ahead, there is a lot of economic data due for release from Australia and Canada. The most significant of which will be the Reserve Bank of Australia monetary policy meeting. Even though interest rates are expected to remain unchanged at 7.25 percent, it will be interesting to see if the central bank grows even more hawkish, moving themselves closer to raising interest rates. In addition, Australian has retail sales, service and manufacturing PMI numbers due for release while Canada will be releasing their IVEY purchasing managers index.

Yen Crosses Weighed Down by Further

The Japanese Yen crosses continued to crumble under the weight of the Dow. On Thursday, stocks were down more than 300 points and on Friday, it added another 100 points to the losses. None of the yen crosses managed to escape unscathed. Japanese economic data was mixed with household spending dropping more than expected while consumer prices and industrial production improved. Next week, the Quarterly Tankan report is due for release. This index of business sentiment has in the past been very market moving, but these days it is far less so. Nonetheless, if business sentiment deteriorates materially, it could add some downside pressure to the Japanese Yen.

Kathy Lien is the Chief Currency Strategist at FXCM.