"U.S. deregulation over the past 20 years has created a flexible, resilient economy that can absorb and recover from shocks that would have caused deep recessions in decades past."
Alan Greenspan
Federal Reserve Chief
Wednesday, October 12, 2005 17:10 GMT

A Win That Feels Like a Loss

The greenback gained 29 basis points on the euro by end of the week but for most FX traders the price action looked more dollar bearish than dollar bullish. After breaking the 1.2000 figure and ultimately hitting a low of 1.1913 by Wednesday, the EUR/USD rallied sharply hitting a high of 1.2111 by late Friday afternoon.  The culprit for this dollar weakness was the decidedly soft eco data all of which surfaced at the end of the week. While the Trade deficit printed a touch better than expected, the -$59 Billion figure still represented the third worst result on record. That news was followed by terrible Industrial Production data which came in at  -1.3% vs. -0.4% expected and of U of Michigan gloom which recorded a reading of 75.4 vs. expectations of 80.  In the midst of this medley the CPI numbers managed to confuses everyone as headline  registered the biggest jump this century at 1.2% but ex-food and energy the gauge only managed to rise 0.1% confirming our thesis that stagflation is starting to grip the US economy.

Next week a smattering of second tier Industrial data which may refute some of the slowdown in the IP numbers if it prints improvement as expected. More importantly will be the results from the TICS report due Tuesday. If foreign flows still show a massive surplus vis a vis the Trade deficit, the greenback should be safe from further weakness. However if TICS falls materially the dollar bulls could be in for a world of pain.    

"We must be strongly vigilant to avoid this effect (inflation risks). We are living in a world with a lot of uncertainties and one of these uncertainties is oil prices."

Jean-Claude Trichet
European Central Bank President
Thursday, October 13, 2005 14:41 GMT

Europe Feels Inflation                         

A very quite calendar in Euro-zone provided few triggers for traders last week. The one bright spot was the jump in Italian Industrial Production to 1.3% from 0.4% expected. We noted that, “The lower euro is helping Italian industry to compete in global markets and should pacify Italian PM Berlusconi from making his periodic complaints about the unfairness of the unified currency.”

The true news of the week was the growing realization by the ECB that EZ inflation is percolating above the banks own 2% maginot line. With inflation in Germany rising to its fastest pace in four years the ECB may not have any choice but to begin hiking rates in the near term which should be a bullish development for the euro which has been suffering from ever widening interest rates differentials to the dollar.

Next week the market will focus on the ZEW survey which jumped unexpectedly to 38 last month and is expected to improve further to 42. Traders will also eye Industrial Production which is projected to rise 1.0% on a year over year basis. Overall, the fundamental background for the week should be euro supportive and if the US data continues to disappoint the single currency may have more room to rally.    

"The central bank could end its super-loose monetary policy before the start of FY 2006 (year to March 2007) next April. As to when we can discuss the possibility of changing the current policy, I think that chances will grow stronger towards fiscal 2006."
Toshihiko Fukui
Bank of Japan Governor
Wednesday, October 12, 2005 10:14 GMT

Yen Spikes to 4 Year Lows

Another week, another divergence between yen fundamentals and USD/JPY price action.  While the eco data continued a string of positive surprises the currency pair set 4 year highs hitting 115.13 on Wednesday. The yen continues to be pressured by high oil and carry flows though Wednesday price action did have the look of an exhaustion high. Meanwhile Japanese data continued to perform well with Japanese Machinery Orders skyrocketing by 8.2% on a month over month basis versus expectations of only a 2.5% gain. We also noted that, “Adding to …. good news was our favorite Japanese economic report - the Eco Watchers survey. This measure of “man in the street” sentiment from barbers, taxi drivers and waiters, rose to 51.7 from 50.8 projected. The larger than expected gain suggests that Japanese Household spending, boosted by firm employment data should improve going forward.” In short any weakness in the oil market  should provide the necessary trigger for dollar bulls to book their profits sending the pair back to the 112.00 figure  

"The alarming manufacturing figures, the decline in confidence balances across all sectors, and the fall in all the export balances are the most disturbing features of the Q3 results. Manufacturing has persistently failed to sustain recovery, and the technical recession seen in the first two quarters of 2005 is very worrying."
David Frost
BCC's Director General
Thursday, October 13, 2005 14:37 GMT

Pounding Likely to Persist

Although the pound was the best performing major against the dollar this week. rising 60 points the internal pressures in the UK economy may continue to weigh on the currency. UK employment data produced mixed results with the claimant count rising to 8.2K vs. 3.3K projected, the eighth consecutive monthly rise.  The data contained some good news as well, namely that average earnings ex-bonus rose by better than expected 4.0% on a year over year basis. Overall, at 4.7%, the UK economy still maintains one of the lowest unemployment rates in G-7  universe second only to Japan's 4.3% rate.

The battle for the economic future of England however is being fought between British Retail Consortium and the Bank of England with the former demanding lower rates to stimulate consumer demand and the latter maintaining a hawkish stance as concerns mount over escalating inflation. For the time being the BOE appears to have the upper hand as UK eco data though hardly robust, appears to have stabilized providing cover for the Central Bank to keep rates steady, but if this week's UK retail sales show yet another disappointment, talk of rate cuts will once again preoccupy the markets

Slight Swiss Retrace

The Swissie actually ended the week as the worst performing major against the dollar, but in actual terms the drop was rather small declining only 36 basis points. With Retail Sales continuing to show impressive growth (up 4.2%) the unit should maintain its strength especially If US data shows any hints of weakness.

The calendar this week only contains the CPI data which despite the higher costs of oil is expected to remain rather muted at 1.2% on a year over year basis.   

Boris Schlossberg is a Senior Currency Strategist at FXCM.