US Dollar, Japanese Yen Benefit from Low Volumes - US Retail Sales Could Slump Next Week

The US dollar and Japanese yen drifted higher yet again on Friday, as low liquidity left the major currency pairs to trade in tight ranges. The shift to higher volumes when the markets open next week, however, creates breakout potential for pairs like EUR/USD and GBP/USD since they are trading near such critical support levels. That said, the direction of these moves will likely depend on investor sentiment, as risk averse selling during the Asian trading session on Sunday could easily send the greenback higher due to flight-to-quality.

Looking to the next piece of US event risk, on Tuesday the Commerce Department is forecasted to report that US retail sales rose 0.4 percent in March, after slipping 0.1 percent in February, and excluding autos retail sales are anticipated to edge 0.1 percent higher. However, there may be downside risks for this reading as the latest ICSC chain store sales numbers show that the contraction in consumption accelerated during March. Indeed, deteriorating labor markets, tight credit conditions, and a year-long recession weighs heavy on the minds of consumers, but as we’ve seen with reports like US non-farm payrolls, the impact of a disappointing result may be mixed as the Federal Reserve has already cut the fed funds target to a record low range of 0.0 percent - 0.25 percent and has no room to cut further. As a result, traders should keep risk trends in mind, as flight-to-quality tends to benefit the US dollar, even if the US fundamental picture worsens.

British Pound Continues Consolidation Above 1.4600 - Breakout Potential

The British pound has remained contained to a tight range versus the US dollar of 1.4600-1.4750 following Thursday’s Bank of England rate decision, as they left the Bank Rate at a record low of 0.50 percent, as expected, which marked the first “no change” decision since September 2008. The BOE Monetary Policy Committee’s (MPC) statement was short and sweet, providing little in the way of new information. The MPC did indicate that they would continue with the quantitative easing efforts announced on March 5, but that it would take another two months before the program was completed because they had only purchased 26 billion pounds in assets of the planned total of 75 billion pounds. Ultimately, there are still significant downside risks for the UK’s economy and financial system, but as it stands, the markets are broadly anticipating that the BOE will continue to leave the Bank Rate at 0.50 percent throughout the remainder of the year, since further reductions are unlikely to have much of an impact. In the near-term, it may be worth looking for a GBP/USD break out of its recent range, but if risk aversion returns, the pair’s break could be a bearish one.

Euro Holding Above Key Support at 1.3100 - Declines May Be in Store

The euro fell further against the US dollar and Japanese yen on Friday, with EUR/USD now holding above key support at 1.3100 and EUR/JPY holding above the 20 SMA at 131.47. There will be additional downside risks for the currency next week, as Eurostat inflation estimates for the Euro-zone have shown that CPI may have fallen to a 0.6 percent annualized pace during March, which would mark the lowest since recordkeeping began in 1991. More importantly, though, the data would highlight that inflation remains well below the European Central Bank’s 2.0 percent inflation target. If Eurostat confirms this at 5:00 ET, or revises the results to the downside, the euro could pull back, especially since the markets are pricing in a small chance of a 25 basis point cut by the ECB on May 7. On the other hand, if CPI is higher than anticipated, the currency could gain as the markets will speculate that the central bank may pause in their efforts to make monetary policy more accommodative. Ultimately, there seems to be more evidence that the ECB will reduce rates at least one more time next month after the final reading of Q4 GDP was unexpectedly revised to a new record low of -1.6 percent, ECB Governing Council member George Provopoulos said that the bank’s benchmark rate could be cut by at least another 25 basis points, and as the ECB’s monthly bulletin highlighted their concerns about growth both domestically and abroad, as well as the potential for inflation figures to fall negative mid-year.

Australian Dollar, Canadian Dollar Consolidate Below Monthly Highs

The commodity dollars ended Friday down very slightly, as the Australian dollar and Canadian dollar consolidated below key highs against the greenback, but next week, the New Zealand dollar and Canadian dollar will face some key inflation reports next week and unlike regions like the US and Euro-zone, price growth has remained relatively robust, leaving potential open for sharp declines on an annualized basis. On Thursday, New Zealand's consumer price index is forecasted to have risen 0.3 percent during Q1, bringing the annual rate down to a more than one year low of 3.0 percent from 3.5 percent. During Q4 2008, prices contracted for the first time in two years and by the most in ten years, so unless we see another surprise contraction during Q1, the news may not add to speculation that the Reserve Bank of New Zealand will cut rates again during their next meeting on April 29. As it stands, a Bloomberg News poll of economists is reflecting expectations for a 50 basis point cut to 2.50 percent, while Credit Suisse overnight index swaps are forecasting a 25 basis point reduction to 2.75 percent. As a result, this upcoming inflation report could be highly market-moving for the New Zealand dollar, but if inflation pressures prove to be stronger than anticipated, the currency could rally.

Meanwhile, according to the Bank of Canada’s last Monetary Policy Report in January, the Bank expects core inflation to fall throughout 2009 to a low of 1.1 percent, while headline inflation is expected to fall below zero for two quarters in 2009. Friday’s reports will provide an update on how these trends fared during Q1, as the consumer price index (CPI) readings for the month of March will be released. Headline CPI is anticipated to have risen 0.3 percent during March, but the annualized measure should remain well above zero at 1.4 percent. Meanwhile, core CPI is projected to have increased by 0.2 percent, leaving the annualized rate at 1.9 percent. All told, these numbers will reflect fairly stable price growth, albeit below the BOC’s 2 percent target, but if the figures reflect a contraction in prices, the Canadian dollar could pull back across the majors. On the other hand, resilient price growth could contribute to Canadian dollar gains, as the moves would suggest that the Canadian economy is holding up better in the current environment relative to other major economies, like the US.

Terri Belkas is a Currency Strategist at FXCM.