US Dollar - Forecast For Friday’s US Retail Sales, Producer Price Index

Despite the release of bearish US data, the US dollar was strong across the majors for much of the day as risk aversion remained the predominant them. In fact, the US trade deficit widened to the most in 16 months in July, while US import prices fell in August by the most since record-keeping began 19 years ago due to weaker commodities and a strong greenback during the survey period. As Quantitative Analyst David Rodriguez discussed this morning, the CFTC's latest Commitment of Traders report shows that speculative US dollar longs have gained to their highest levels since late 2005, which is a clear sign that forex trading sentiment has become extremely bullish the US dollar. Though short and medium term momentum remains in its favor, the exceedingly high level of speculative forex future long positions increases the likelihood of sharp pullbacks, like we saw at the end of Thursday’s US trading session.

Indeed, the move may indicate the beginnings of a turn, as the DJIA rocketed higher during the final 30 minutes of trading on news that Lehman Brothers was in talks with prospective buyers. Likewise, high-yielders and the JPY crosses picked up as well, and if this sentiment holds overnight and into tomorrow morning, the release of US Advance Retail Sales and the Producer Price Index could play well into the hands of dollar bears. According to Bloomberg News, retail sales are forecasted to edge slightly higher during the month of August, though excluding autos they are anticipated to fall. There is significant downside risk for this release, as wholesale sales slumped 0.3 percent during the month, while International Council of Shopping Centers (ICSC) sales slowed to a 1.7 percent annual pace in August from 2.5 percent thanks to a pullback in spending on discretionary items such as apparel and furniture. Meanwhile, as we saw in the release of the import price index, the plunge in commodities during the month of August resonated throughout the markets, and as a result the Producer Price Index for that month is likely to plummet as well.

Euro Consolidates Above 1.39 As ECB Bulletin Leaves Markets Pricing in 50bps In Rate Cuts

The EUR/USD pair made a clean break below 1.40 just before Wednesday’s New York close, and since then euro has consolidated above 1.39 as the European Central Bank’s monthly bulletin left the markets pondering the potential for a rate cut in the near-term. The ECB noted slowing growth as they said, “the euro area economy is currently experiencing an episode of weak activity characterized by high commodity prices weighing on consumer confidence and demand, as well as by dampened investment growth.” However, the central bank was somewhat optimistic about the outlook, noting that a persistent drop in oil prices from their record highs in July should “help strengthen real disposable income, with the level of employment remaining high and the unemployment rate low by historical standards.” Meanwhile, the ECB remained hawkish as they forecast that annual inflation rates would remain well above their 2 percent target for a “protracted period of time” while “upside risks to price stability over the medium term prevail.” This hawkish stance was not enough to quell rate cut speculation, as Credit Suisse overnight index swaps are now pricing in nearly 50bps in reductions by the ECB over the next 12 months, compared to 25bps in cuts just two weeks ago. Thus, from a fundamental perspective there’s still downside risk for the euro, but from a technical perspective, looming support may prevent significant declines from current levels. Indeed, the 50% fib of 1.1638 - 1.6041 at 1.3840 aligns with the July 2007 highs near 1.3850, providing a good profit-taking level for EUR/USD bears.

Japanese Yen Consolidates As Financial Markets Remain Jittery - Q2 GDP Anticipated To Contract Sharply

Like the US dollar, the Japanese yen was strong for most of the day on signs of market-wide risk aversion, but news the Lehman was in talks with prospective buyers helped lead risky assets higher. This move was to the detriment of the yen primarily, though the US dollar suffered as well. Furthermore, we continue to see that Japanese fundamentals have little bearing on the currency, as the latest forex correlations report shows that carry trades and the DJIA have increasingly been moving in lockstep (though the correlation is not as high as it was in 2007). Nevertheless, traders should not ignore the release of the final reading of Japanese GDP, as the economy is expected to have contracted sharply during Q2. In fact, GDP is forecasted to fall an annualized 3.1 percent, the worst result since Q3 2001. Going forward, the Japanese yen will continue to depend on the status of risk appetite in the market, and while the currency could pull-back in the near-term, I still think there is long-term bullish potential for the low-yielder. As a result, I will look for JPY buying opportunities on sharp declines.

New Zealand Dollar, Australian Dollar Struggle to Recover as Risk Trends To Decide Fate of High-Yielders

The New Zealand dollar and Australian dollar have been particularly vulnerable to risk trends, as the high-yielding currencies slumped with commodities and equities for much of the day, only to rebound with the DJIA at the end of the US trading session. While the Reserve Bank of New Zealand slashed rates by 50bps to 7.5 percent yesterday, the Kiwi remains a prime carry trade currency. In economic news, New Zealand retail sales fell more than expected in July, as a plunge in auto sales led the headline figure down 0.8 percent. Excluding autos, sales were still disappointing at -0.2 percent. The data underpins the RBNZ’s rate cut, especially as RBNZ Governor Alan Bollard said the economy was experiencing a major slowdown that would be "led primarily by the household sector." The New Zealand dollar fell versus the US dollar on the news for a test of support at 0.6500, but given the pickup in risk appetite over the past few hours, NZD/USD may be able to recover overnight.

Terri Belkas is a Currency Strategist at FXCM.