Can The Dollar Recover?

Last week we noted that dollar’s fate was in Fed’s hands stating that, “as the FOMC rate announcement takes place on Wednesday currency traders will get a much better idea if Chairman Bernanke is serious about raising rates or is merely bluffing.” After the Fed’s ambiguous statement the markets decided that the FOMC is not truly serious enough about fighting inflation and the greenback fell across the board.

We wrote on Friday, that the Fed missed a golden opportunity to surprise the market with a rate hike this week, which no doubt would have hurt stocks but may have also broken the back of oil speculators by strengthening the dollar while making credit more expensive. Instead FOMC’s dilly-dallying produced the worst of all worlds. Oil prices skyrocketed breaking the $140/bbl handle, stocks fell sharply as a result and the dollar continued to weaken not only against the euro, but the yen as well.

With the greenback clearly on the defensive, next week shapes up to be even more interesting than the last. Because of the July 4th holiday the NFP report will be released on Thursday rather than Friday right at the same time as the post rate announcement news conference by the ECB. The volatility in the pair could therefore be massive, especially if there are surprises on both side of the equation.

If US employment situation deteriorates more that the market expects (and given the recent trend in jobless claims there are good reasons to think that it will) the prospect of Fed rate hikes will dim even more. Therefore the combination of progressively worse US economic data along with relentlessly restrictive ECB monetary policy may create even more weakness for the dollar in the days ahead and lay the foundation for another runs at all time highs.

Euro One and Done or More to Come?

One and done or more to come? That’s going to be the key question for the currency markets next week as attention turns to the ECB rate announcement meeting on Thursday. At this point given the persistently hawkish rhetoric coming from the monetary authorities in Frankfurt, the market is near universally convinced that the ECB will hike rates by another 25bp on Thursday. European monetary officials are deeply concerned about the steep rise in headline inflation gauges (the latest reading showed a year over year rise of 3.7% - well above the central banks target of 2%) and are attempting to anchor intermediate term inflation expectations even at the risk of slowing down the region’s economy.

However, in the prior post conference question and answer session President Trichet was careful to stress that the ECB does not intend to enact a series of rate hikes. The question therefore going forward is whether the ECB chief will signal that central bank considers next week’s move to be sufficient or whether the monetary policymakers will be open to yet more tightening before the year end.

As we noted above the combination of ECB rate announcement and NFPs on the same day creates the possibility of massive volatility as traders react to the news on both sides of the Atlantic. As for the front of the week, Monday CPI and Tuesday German Retail Sales should contribute to the hoopla. If, as expected, the inflation data remains hot and the Retail Sales rebound, ECB’s hawkish posture will only stiffen providing further support to the euro.

USD/JPY, Stock Markets Rack Up Heavy Losses Amidst Risk Aversion

After weeks of range-trading, USD/JPY finally broke lower as risk aversion made a comeback. Indeed, US stock markets like the DJIA – which holds a correlation with the Japanese yen crosses – took a heavy hit on Thursday morning as Goldman Sachs downgraded Citigroup and General Motors shares, and also downgraded the entire US brokerage sector from “attractive” to “neutral.” This only served to exacerbate the market’s bearish sentiment on the financial sector and has stirred fears that the worst for the credit markets has yet to come. Risk aversion remained the primary driver of the markets on Friday as well, leading the USD/JPY to plummet and weighing the DJIA down for a test of 11,300 and down 20 percent from October’s record high.

As usual, Japanese economic data had very little impact on the low-yielding yen, as the currency gained despite disappointing household spending and small business confidence readings. Furthermore, the Business Sentiment Index (BSI) for large industries slumped to -15.2 from -7.2, which was the worst reading since the government started keeping records in 2004. Clearly, a slowing global economy is taking a toll on export-dependent Japan, particularly producers. Unfortunately, consumers are highly unlikely to pick up the slack, as tepid wage growth and rocketing food and energy prices squeeze disposable income, and thus, leaves little for discretionary spending. As a result, prospects for Japanese GDP remain weak.

Looking ahead to this week, Japanese data is anticipated to reiterate this sentiment as the Bank of Japan’s Tankan survey will likely fall in line with the government’s BSI report. However, the Tankan release is considered to be a bit more influential as it will give a glimpse as to what the central bank’s view is on the economy. While the Bank of Japan is not likely to consider cutting rates anytime soon given strong consumer price pressures, the data could still weigh on the Japanese yen. Nevertheless, with risk aversion likely to remain the predominant theme in the markets even in the week ahead, the odds are a bit more in favor of Japanese yen strength (USD/JPY weakness).

The Pound Points To A Breakout But Will Momentum Confirm It?

The British pound marked a significant breakout against its US counterpart towards the end of the last week suggesting months of range trading may be giving way to a major trend change. Since November, GBP/USD has been cutting a broad wedge that has been working its way towards an inevitable apex. Support in this seven month trend was relatively level around 1.94, but resistance has been steadily falling with lower highs in a trendline that was crossing 1.98. Come Thursday, there was little direction in the pound itself; but a market-wide selloff in the US dollar would ultimately provide the trigger for the quick move above 1.98. What’s more, looking at the development in positioning up until – and through – this technical drive, it is clear that such a move was overdo. The COT had shown speculative positioning trending towards extreme net shorts for some time. Confirming this, the SSI revealed retail traders were growing complacent with trading the mature range. When GBP/USD finally pushed above resistance, the SSI ratio plunged to -2.92 – the most extreme short interest in the pair since November – as traders clinged to hope that the range would hold up.

Despite the significant volatility and strength for the sterling in the GBP/USD this past week, fundamentals were very discouraging. For the housing market, the Rightmove House Prices indicator marked its worst contraction in a year, further cooling the annualized rate to a 0.1 percent clip – the slowest pace on records going back to 2002. A drop in average home values was not unexpected and neither was the drop in mortgage applications given the drop in demand with consumer confidence drying up and mortgage rates rising. The BBA reported loans for home purchases plunged 20 percent to 27,968 and the lowest level since February 1996. Far more concerning though was the final GDP numbers. As usual, economists were expecting the final calculations to match the previous measurement, but this was not to be. Growth rose a modest 0.3 percent through the first three months of the year, the slowest pace of expansion in three years, thanks largely to the worst level of level of service sector activity in 12 years and a steep drop from fixed investment trends.

In the week ahead, the market will no doubt be focused on GBP/USD as more capital will be waiting on the sideline for confirmation that a major trend is forming. For event risk, the week’s UK data will not likely contribute to a sterling rally above 2.00. Action begins early on Sunday with the GfK consumer confidence – expected to drop to a new multi-year. From there, the Nationwide House Price and BoE Housing Equity Withdrawal figures are expected to highlight the problems in the residential sector. Making things far worse, the services, manufacturing and construction PMI numbers look to stoke fears of a contracting economy through the second quarter. Nonetheless, GBP/USD may still have its rally if the major US data (ISM manufacturing, services and NFPs) reflects the weakness in its own country.

Swiss Franc Rallies On Risk Aversion

The Swiss Franc was the beneficiary of renewed risk aversion as fears grew that the subprime crisis still has life. The failure of the U.S. housing sector to stabilize has led to fears that many banks will need to take further right downs as the assets on their balance sheets continue to lose value. A Goldman Sachs downgrade of Citigroup was the match that started the fire sale of stocks. The Dow would ultimately lose almost 360 points on Thursday, sending it to its lowest levels in two years and before the Bear Stearns bailout. Even though many of the Swiss banks are among those that are exposed to the downside risks, the currency’s reputation as a safe haven led to its appreciation against the dollar. Oil reaching above $140 a barrel for the first time raised concerns of slowing global growth and led to the unwinding of carry trade’s. The week ended with the KoF’s leading economic indicator reporting its lowest reading in almost five years. The dour fundamental data would trip up franc bulls, as it reminded traders that the country’s economy is slowing.

The Swiss economy is clearly slowing down as its main trading partner Europe continues to show signs of contracting and the headwinds from the U.S. continue to impact exports. The upcoming SVME-PMI reading is expected to demonstrate the manufacturing sector’s weakness as it is anticipated to decline to 55.0 from 55.7 the month prior, which would make it the fourth decline in five months and the second lowest level since August 2005. Indeed, the State Secretariat for Economic Affairs (SECO) lowered its growth forecast for the country to 1.3% from 1.5% as it expects demand for Swiss goods to decline, as the country’s strong currency is making its goods less competitive in conjunction with the other existing headwinds. Additionally, Oil prices will only weigh further on domestic demand which is weakening under the pressure of 15 year high inflation. Consumer price are expected to rise further, as economists are predicting them to increase to 3.3% from 2.9% the month prior. Despite, the significance of the fundamental data on the upcoming economic calendar, ultimately the USD/CHF’s fate may rest in the hands of risk sentiment. An improvement in U.S. consumer spending has calmed fears a bit, but equities remain heavy and as oil prices continue to suppress the outlook for the global economy, risk aversion will prevail. However, if the recent rise in oil proves to be a blow off top and traders start to price in the anticipated demand destruction due to the global slowdown, then we may see broad based dollar strength.

Canadian Dollar May Trade To Parity On Record Oil Prices

The Canadian Dollar rallied against its US namesake, as a broad sell-off in the American currency and fresh record-highs in crude oil prices dropped the USD/CAD to month-to-date lows. An effectively empty Canadian economic calendar meant that the currency traded off US dollar event risk, and disappointing Greenback news easily doomed the USD to further declines. The highly-anticipated US Federal Open Market Committee rate decision grabbed headlines as the central bank left interest rates unchanged and showed relatively little motivation to raise rates through the near term. Such developments came as a disappointment to many US dollar bulls who had hoped high inflation rates would force a much more hawkish stance from the Fed, and currency traders responded by selling US dollars en masse. It is subsequently little surprise to note that the US dollar is the worst-performing G10 currency through the past week of trade—falling against every single major counterpart. Given comparatively bullish forecasts for the future of Canadian interest rates, bearish forecasts for US yields will likely translate into further USD/CAD selling pressures through the medium term.

Short-term Canadian dollar price action will likely depend upon the coming week’s key Gross Domestic Product report, while a number of important US economic data releases will likewise drive volatility in the USD/CAD pair. Analysts forecast that the Canadian economy grew a modest 0.2 percent through the month of April—a 0.4 percentage point improvement from the previous month’s 0.2 percent decline. A positive print would likely go a long way to dispel fears of a longer period of negative economic growth and similarly boost prospects for the domestic currency. USD/CAD traders will otherwise monitor a busy US economic calendar, with an always-market-moving US Non Farm Payrolls report almost guaranteed to drive sharp price moves through Thursday’s trade. Sharp disappointments in Thursday’s NFP’s would likely lead to a noteworthy drops in the USD/CAD, but the Canadian dollar may nonetheless lose ground against other forex counterparts on bearish US economic developments. Given the country’s clearly strong trade dependence with the US, any sign that the labor market continues to shed jobs would likely bring lower consumer demand for foreign goods and services. It will be important to watch for unexpected results out of either Canadian GDP or US NFP reports, and overall risks arguably remain to the downside for the USD/CAD through near term trade. Given clear strength in crude oil prices and improving Canadian-US yield differentials, the Loonie currently holds the upper hand over the downtrodden American currency.

More May Data, More Aussie Selloff?

The Australian dollar calendar was fairly light last week, leaving the pair to play out along established technical levels. Things started off with a sharp contraction in May’s New Motor Vehicle Sales as the annualized growth rate declined to 2.6% from 3.4% in April. The result fits neatly into the broad theme of a slowdown in domestic consumption as Australians weather record-high borrowing costs and booming commodity prices. Interestingly, Job Vacancies showed slight improvement, adding 3.4% from March to May. On balance, the reading goes just barely farther beyond reversing a loss of -2.7% seen from December to February. This is consistent with a flattening in labor demand as economic activity winds down. April’s edition of the Conference Board’s leading index showed improvement (0.3% vs. -0.4% in March), but the metric is far too backward-looking at this point to stir the markets given the decidedly bearish tone of May releases. The Australian dollar paid little heed to these releases, continuing a technically driven relief rally to re-test support-turned-resistance at the upward-sloping trend line that was penetrated following May’s abysmal Employment Change report (-19.7k versus 13.5k expected). The trend line acted as significant support for AUD/USD since August of last year and its penetration is likely indicative of a looming trend change for the heretofore buoyant high-yielder.

This week, the calendar fills out with ample fundamental releases due to hit the wire. May’s New Home Sales data is likely to show continued weakness in the housing sector. The metric posted a meager 0.1% increase in April following a sharp -6% decline in March. With a slowing economy and high borrowing costs standing in their way, Australians are unlikely to take on big-ticket purchases. Tuesday’s RBA rate decision is likely to bring further inaction. The growth is clearly on a slowing path, meaning Glenn Stevens and company can sit back and allow macroeconomic forces to take their toll on inflationary pressure. May’s Retail Sales can be expected to show weakness following April’s contraction of -0.2%. The loss of -19.5k jobs in the same period is hardly a boon for consumer confidence, meaning retail activity will suffer. The week concludes with May’s Trade Balance report. April saw Australia's trade deficit contract, printing at -A$957 million versus the expected -A$1700 million. Record high borrowing costs and booming food and petrol prices crimped consumption, bringing import volumes down by -2% from March. Meanwhile, exports had room for improvement with weather-related constraints out of the way (heavy rains caused floods in March, disrupting the flow of exports). Shipments of coal and iron ore rushed to reach pre-flood output levels, with the former rising a whopping 23%. Traders will be looking to see if more of the same this time around will force the RBA’s hand in the fourth quarter as mining derails the disinflation. On balance, the slew of May releases could prove to be the fuel behind a AUD/USD selloff now that prices have retraced to technical support-turned-resistance.

Data Points Downward For The Kiwi Dollar

The New Zealand docket painted a grim picture of the economy last week. Things started off with a relatively benign Current Account release. The deficit narrowed less than economists expected in the first quarter, revealing a shortfall of -NZ$2.16 billion versus the forecast -NZ$1.67 billion. Still, this is the lowest deficit in nearly four years. A 20% appreciation in dairy prices helped bolster export figures, improving the trade side of the Current Account equation. That said, most of the gap comes from the investment income portion of the metric. The balance on goods and services shows a surplus of NZ$1.26 billion, while the balance on income and transfers shows -NZ$3.41 billion. Put simply, foreigners earned more from New Zealand's assets than New Zealanders earned from investments abroad. Looking ahead, the current improvement is likely short-lived. Oil prices rose substantially in the second quarter, which will surely inflate the cost of imports. Meanwhile, a drought is to cut farm production and depress export volumes. These developments will cause the goods and services portion to deteriorate, bringing the headline figure lower on the next release. Bolstering this argument, the Trade Balance underperformed, showing a deficit of –NZ$196 million in May versus an expected surplus of NZ$150 million.

The knock-out punch came as it was revealed that the economy shrank in the first quarter, posting negative GDP growth at -0.3%. This marks the first quarterly contraction since the last part of 2005. The economy continues to falter under the weight of record-high interest rates alongside record oil and food prices. The burden to growth has become so profound that RBNZ Governor Alan Bollard has recently announced that the bank will be looking to cut borrowing costs by the end of this year for the first time since 2003.

This time around the calendar is notably bare. June’s NBNZ Business Confidence reading will offer a timely look at the end of the second quarter and can be expected to fit with the broader theme of broad economy-wide slowdown. Persistently high input prices can only add to firms’ negative sentiment. June’s Commodity Price index may decline following an easing in dairy prices through June, dragged down by New Zealand’s biggest export item.

Boris Schlossberg is a Senior Currency Strategist at FXCM.