The US dollar continued to rally on Friday, helped by a rise in the University of Michigan/Reuters US consumer confidence survey. Indeed, the index reflected improvement for the second consecutive month in August, rising to a 4-month high of 61.7 from 61.2, though it just missed expectations of 62.0. Looking at a breakdown of the report, the pull-back in oil prices since mid-July appears to have had a huge impact, as the most noticeable change in the index was the drop in 1-year inflation expectations to 4.8 percent from 5.1 percent. Likewise, with inflation expectations easing, consumers are feeling a bit better about the economic outlook, as that index rose to a 5-month high of 56.8 from 53.5. Nevertheless, with job losses in the US mounting, credit conditions remaining tight, and food and energy prices still relatively high, the index gauging sentiment on current economic conditions slumped to 69.3 from 73.1. This suggests that the average US consumer is not necessarily ready to head to stores and shop again just because oil futures are down, and as a result, significant downside risks to growth remain. More tellingly, Credit Suisse overnight index swaps moved sharply on Friday to price in 38bps worth of hikes by the Federal Reserve over the next 12 months, down from 71bps on Thursday. Meanwhile, forex positioning as measured by FXCM SSI signals that traders are growing less bearish on the currency. Since SSI is a contrarian indicator, the shift suggests that the US dollar could be in for losses soon and combined with the change in interest rate expectations for the Federal Reserve, next week could finally see a pullback in the US dollar.

British Pound Recovers Following Early Morning Test of 1.8520

Following an early morning test of 1.8520, the British pound finally managed to gain on Friday as the currency remains extremely oversold. In fact, as Quantitative Analyst David Rodriguez noted in his British pound forecast, the currency may be due for a bounce after 11 consecutive down days – the worst losing streak in the past twenty years of forex trading. Heavy event risk looms for the GBP/USD pair next week though, including the release of the minutes from the BOE’s August policy meeting, UK retail sales, and the second reading of Q2 GDP. In the BOE meeting minutes, traders should watch the vote count, as more than one vote for a rate cut or hike could trigger sharp directional moves in the pair. Meanwhile, UK retail sales are anticipated to slow for the second consecutive month during July at a rate of -0.2 percent, helping to drag the annual rate of growth down to a more than 2-year low of 1.8 percent. The data would be in line with the British Retail Consortium’s (BRC) July survey, which indicated that consumers tightened their purse strings and led same-store sales to tumble 0.9 percent from last year. Finally, Q2 GDP is expected to be revised down to an annual rate of 1.5 percent from 1.6 percent, matching the Q1 1993 low. With recent PMI reports reflecting contraction in the services, construction, and manufacturing sectors, there may be additional downside risk for this particular reading. My fundamental bias for the British pound early next week: bullish. Thereafter, though, GBP/USD could fall lower.

Euro Hits Fresh 6-Month Low

The Euro continued its collapse on Friday, hitting fresh 6-month lows near 1.4660 as interest rate expectations remain in control. Indeed, Credit Suisse overnight index swaps are still pricing in nearly 40bps worth of cuts by the European Central Bank within the next 12-months. Looking ahead to next week, the Euro may only serve as an anti-dollar trade, though there will be a few indicators to watch. First, the release of the German ZEW survey on Tuesday tends to ignite short-term volatility for the Euro. On Thursday, the August PMI readings for the manufacturing and services sector will be released, and both are anticipated to remain below 50 (signaling a contraction in business activity).

Canadian Dollar, New Zealand Dollar Surge Despite Drop In Commodities

The New Zealand dollar and Canadian dollar both rallied against the US dollar on Friday – despite broad declines in commodity prices – as the overbought dollar pulled back. The Australian dollar, on the other hand, remained heavy as gold experienced its biggest weekly decline in 25 years and fell below $800/oz for the first time since December. The declines in commodities continue to suggest massive deleveraging market-wide, as traders exit once-profitable positions en masse. Like the extensive rally in the US dollar, the oversold nature of the commodity dollars may leave them prone to bounce next week, but in the longer-term, there is still significant downside risk for Aussie, Kiwi, and the Loonie. Consequently, rallies in these currencies should be seen as selling opportunities. Looking ahead to next week, the Canadian dollar faces the most event risk as retail sales and CPI will both be released. Consumer spending in Canada is expected to have held up at a solid 0.4 percent pace in June. However, traders should also watch the release of Canadian wholesale sales on August 19, as this tends to be a very good leading indicator for the headline retail sales report. Meanwhile, Canadian inflation data for the month of July is likely to remind the markets that the BOC has been somewhat hawkish in their rhetoric lately, as headline CPI is forecasted to rise to an annualized rate of 3.3 percent – the highest since March 2003 – while the core measure is expected to edge up to a 8-month high of 1.6 percent.

Japanese Yen: Still Mixed Across the Majors, Upside Risk Remains for the Low-Yielder

The Japanese yen saw an exceptionally wild week of trading, rocketing more than 1 percent higher against most of the majors while tumbling almost 1.5 percent against the New Zealand dollar and Canadian dollar. What gives? There was a clear breakdown in carry trades as volatility picked up, interest rate expectations across the majors shifted, and USD/JPY risk reversals fell. Furthermore, there was the drop in interest rate expectations for the Bank of Japan, as they are now pricing in absolutely no change as of August 15. Of course, traders also need to keep in mind that a jump in risk aversion could trigger gains for the Japanese yen if the correlation between the DJIA and USD/JPY improves.

Banco de Mexico Hikes Rates to 8.25%, South African Rand, Turkish Lira Consolidate Losses

The Banco de Mexico hiked rates by 25bps on Friday to 8.25 percent as expected, but the Mexican Peso subsequently slipped lower after the central bank said that slower growth and falling commodity prices may reduce the need for further monetary policy tightening. Meanwhile, sharp declines in gold prices weighed on the South African Rand, but USD/ZAR did not manage to break above key resistance as the US dollar rally wanes.

Terri Belkas is a Currency Strategist at FXCM.