US Dollar Depends On Fed For Direction Next Week - Watch What They Say, Not What They Do

The US dollar’s consolidation continued on Friday as US non-farm payrolls (NFPs) failed to have a lasting impact on the currency. While the currency did initially jump across the majors on the news that NFPs were not quite as bad as expected at -51K (consensus expectation: -75K), the greenback pulled back over the following two hours. There were a few factors coming in to play here. First, the unemployment rate actually rose more than anticipated to a 4+ year high of 5.7 percent from 5.5 percent, highlighting the fact that NFPs have fallen for seven months in a row and the labor markets remain exceptionally weak. This was followed by the 10:00 EDT release of ISM Manufacturing, which fell less than expected to a reading of 50.0 in July (consensus forecast: 49.0) from 50.2, signaling a stagnation of activity in the sector. Looking at a breakdown of the report, an increase in production was offset by a contraction in new orders. Meanwhile, the prices paid component surprisingly showed that they grew at a slower pace, which should help to lessen the Federal Reserve's inflation concerns. The most startling part of the release, however, was the surge in the employment component to 51.9 from 43.7, which indicates a marked rise in hiring. This certainly would have been helpful ahead of the NFP release since it was a bit better-than-forecasts, but at the same time, would have been misleading since the report ultimately reflected net job losses in the sector. Looking ahead, Tuesday’s Federal Reserve meeting will be THE key event of next week. However, this has less to do with the actual rate decision (the FOMC is widely expected to leave rates steady at 2.00 percent) and more to do with what they say in their subsequent policy statement, as inflation-focused comments could easily drive the US dollar higher.

Euro Continues to Flounder As Additional Signs of Slowdown Emerge

The Euro did little but consolidate below 1.5580 on Friday, as German retail sales proved to be weaker-than-expected at -1.4 percent for the month of June. While this didn’t necessarily impact the currency much, the release will be useful a leading indicator for next week’s Euro-zone retail sales report and only adds to the pile of evidence suggesting that economic growth in the region is slowing rapidly. As a result, we’re likely to see the European Central Bank leave rates unchanged at 4.25 percent next Thursday. However, like the Federal Reserve, it is commentary by central bankers after the meeting that will have the greatest impact on the Euro. Estimates for Euro-zone CPI in July jumped to a fresh 16-year high of 4.1 percent from 4.0 percent, which is well above the ECB’s 2 percent target as energy and food costs remain high. Thus, there’s little doubt ‘price stability’ will be the foremost concern for Mr. Trichet, but if he suggests that a broad economic slowdown could bring price pressures down in coming months, the euro could actually sell-off across the majors.

British Pound: Manufacturing PMI Adds To UK Recession Risks

On Thursday, we discussed how the British pound remained weak and questioned if GBP/USD would continue to fall to target 1.97. This was indeed the case, as the currency tumbled versus the US dollar, Japanese yen, Euro, and Swiss franc at the start of the European trading session. However, this move actually occurred before the release of UK manufacturing PMI, which hit a decade low of 44.3 in July. This was the third consecutive month that this indicator held below 50 – signaling a contraction in business activity – as factories grapple with rising raw material costs and slowing global and domestic demand. With the UK economy at risk of falling into recession, some Monetary Policy Committee members of the Bank of England – such as David Blanchflower – see an immediate need to cut rates. On the other hand, the June reading of UK CPI jumped further above their 2 percent target to 3.8 percent and upside risks remain, which has encouraged the majority of members to leave rates steady at 5 percent. We expect similar sentiment during next week’s meeting, as the MPC is anticipated to leave rates unchanged once again. Since they are unlikely to issue a monetary policy statement, the market’s reaction to the news should be relatively very muted as traders will await the release of the meeting minutes on August 20 as a gauge of the BoE’s bias.

Australian, New Zealand Dollars Plunge As Commodity Boom Loses Steam

Commodity prices are no longer spiraling out of control, and as a result, currencies like the Australian, New Zealand, and Canadian dollars have plunged in recent weeks. Over the past five days alone, AUD/USD has plummeted nearly 300 points while NZD/USD has dropped almost 200 points. However, both pairs have recently run into some support, but with economic indicators out of the Australian, NZ, and Canadian regions expected to be widely disappointing, the losses for these commodity currencies may not be over quite yet.

Japanese Yen Holds Up Versus Weak Euro, British Pound

Many of the Japanese yen crosses have been mixed lately, with the currency still somewhat weak against the US dollar, but gaining some ground versus the Euro and British pound. There was no pertinent economic data on hand for the currency, though it’s questionable if that matters as the yen is likely waiting for the next big shift in risk appetite market-wide. Since Federal Reserve news can have a huge impact on US equity indexes, traders should look to Tuesday’s FOMC rate decision and policy statement, as this could be a major source of price action for the Japanese yen next week.

Kathy Lien is the Chief Currency Strategist at FXCM.