It was a volatile yet directionless period for the US dollar last week. With only a smattering of second tier economic indicators populating the docket, fundamental traders deferred to dramatic swings in commodity prices, mounting fears of a major bank collapse and ever-exigent and evolving interest rate expectations. However, these market themes were hardly fallback drivers as we have seen the US dollar push right back towards major resistance with traders on both the technical and fundamental side of the fence waiting for each of these pieces to fall into place before confidence in the greenbacks’ dominate trend is revived. No doubt, these market dynamics will play just as prolific a role in the week ahead as they have in the one that has just passed.

With the US dollar rising to new multi-month highs against all of its liquid counterparts, skeptical bears will start to point out the fading interest rate outlook for the Fed as a good reason to reevaluate any long-term dollar rallies. While many G10 central banks are looking at significant rate cuts over the coming year, most of their benchmarks would still be well above the Fed Funds rate even if all the forecasts prove accurate. On the other hand, futures show there is a 68 percent chance that the Board of Governors will keep rates at 2.00 percent through the end of the year. What’s more, considering the evolution of market conditions lately, even these officials forecasts could be construed as being overly optimistic. Commodity prices have tumbled through August (having yet to show through in the lagging inflation reports), consumer spending is threatening to revive fears of a recession and it seem only a matter of time before another major US bank collapses. Of these three, the health of the financial sector is the most immediate concern with Lehman Brothers and Freddie Mac/Fannie Mae both showing fading vital signs.

With these key market dynamics just off in the background, traders will also have to prepare for a number of scheduled economic releases. Housing and consumer-centric data are two general themes, but the key reports will be the minutes from the FOMC’s August rate decision and the revision to the 2Q GDP report. The latter will be particularly interesting as the market consensus is calling for a sizable, positive revision from a 1.9 percent annualized clip to 2.7 percent. If such a figure is met, it would certainly offer the dollar a boost in the short term; but with housing, consumer spending and business conditions all faltering in the months since the first half ended, a consequential advance would merely be setting the currency up for a more magnificent collapse as recession worries regain traction.

Euro: Will the Recovery Continue?

Despite generally weak economic data last week, the Euro managed to recover from Tuesday’s low as the currency consolidates its declines. Indeed, from a technical perspective, it appears that EUR/USD could climb further, and shifting interest rate expectations are working in favor of gains as well. On Friday, Credit Suisse overnight index swaps actually moved to price in just under 25bps worth of cuts within the next 12 months compared to 50bps on Monday.

Looking ahead to next week, there are few major indicators on hand, though some releases can spark short-term volatility. Given the surprising improvement in the German ZEW survey, there is some potential for a gain in the IFO expectations report, though the gauge of current sentiment could ease. Meanwhile, German labor markets are anticipated to perk up for the third consecutive month. Finally, Eurostat estimates for Euro-zone CPI are projected to show that inflation held at a 4.0 percent pace in August. Given European Central Bank President Jean-Claude Trichet’s more bearish stance on economic growth, a weaker-than-expected CPI reading could exacerbate the market’s speculation that the central bank will cut rates within the next year. On the other hand, a jump in CPI could be just the thing to get traders to remember just how hawkish Mr. Trichet can be and send the euro higher.

Terri Belkas is a Currency Strategist at FXCM.