NFPs Hardly Please But Dollar Boom Rolls On

Non-Farm Payrolls - the marquee event of the week- did not produce ironclad evidence of strength that dollars bulls were looking for, but just like in horseshoes, close enough was good enough and after a few minutes of indecision on Friday the EUR/USD plummeted nearly hitting the 1.1800 figure for the first time in a year and half.  The number itself was relatively weak printing 56K vs. 120K expected and as most analysts were quick to point out fully half of that gain came from construction, With housing inventories starting to bulge as a result of higher rates, this hardly bodes well for the rest of the economy unless some other sector can pick up the slack.

Greenback clearly has the momentum now and may well take the EUR/USD to 1.17000 level before the selling is finished. The primary driver for the move has much more to do with sentiment rather than reason. As we reported Friday, our SSI indicator flashed a massive mis-position by our order book, which indicated that the market was simply caught short too many dollars as we saw 3 euro longs for every dollar long. Next week, with the Trade Balance report likely to pour some rain on dollar bulls parade, we prefer to stand aside despite the clear momentum for the buck.    

Paris Burning               

Despite the surprisingly dour German Retail Sales numbers last week which dropped -1.60% versus expectations of a gain to 0.5%, all other Euro-zone data flashed green. The region is clearly benefiting from the lower euro, moderating oil prices and low interest rates. Certainly after the drubbing the currency took this week that simulative effect should fuel even more growth for the export driven region. Thus, the conundrum in the FX market is that a lower euro will eventually lead to a higher euro as growth and interest rates pick up.

However, the unit's weakness this week had little to do with economics. Yes, the interest rate differential certainly weighed on the currency as the Fed moved to 4% money while the ECB refused to pull the trigger on a rate hike and -worse for euro bulls - suggested that it may hold off in December as well. Yet what really sent capitol packing from the common currency were the violent, uncontrollable riots in the suburbs of Paris.  Nothing makes investors more nervous than wanton destruction of property and until calm is definitively restored in Euro-zone's number 2 economy, the euro remains a very high risk proposition.    

Oh the Agony of Anti-Carry!

On Friday we wrote, “As is so often the case in the currency market, it was more than ironic that the yen hit a 26 month low against the dollar reaching … on the same day as Japanese Household spending - a key measure of the country's  battle with deflation - actually rose for the first time in 8 months.  But at present the market cares not wit for Japanese economic data as the single minded focus of most participants is yield, yield, yield! With US rates expected to rise to 4.5% within two months, the 450 basis point carry simply trumps all other trading considerations.” Indeed the yen again registered the worst performance amongst the majors, dropping 223 basis points against the dollar. Yet for those still pondering a long in to the position with anticipation of 120.00 level in mind, we caution that this is the most inscrutable of currencies and could easily drop 300 points in a week, especially if oil prices weaken to $55/bbl.  No doubt the dollar bulls are in full control - but the question is for how much longer?

Mixed Bag of Tricks

UK data was all over the board this week with only PMI Services showing a genuine improvement while the rest of the reports suggested that economy has stabilized but not expanded. Housing data was emblematic of this theme as Nationwide survey showed a rise in prices while HBOS showed housing rates to be flat. Overall, the economic news from UK paints a picture of a general stall in activity which if it persists will force the BOE to cave in and lower rates as we head to 2006.

Speaking of BOE, next week brings the monthly interest rate decision announcement and the market expects rates to remain steady. Ahead of that event will be key data from the Industrial and Manufacturing activity reports which are projected to rebound from the month prior. If that data disappoints in any way the pressure on the BOE to loosen monetary policy will grow immeasurably and may put the whole no-rate-hike assumption in play.

SNB is Sounding Hawkish

Though Swiss PMI Manufacturing data backed off a bit from prior months reading of 57.6, the report demonstrated that Industrial activity in Switzerland remains robust with that number printing at 56.8 More importantly CPI rose to 0.9% from 0.6% projected indicating that inflation lurks just beneath the surface. To that end, SNB Chairman Jean Pierre Roth made a speech this week with strikingly hawkish overtones practically assuring the market of a 25bp hike at the December meeting.

Next week Unemployment data and Consumer Sentiment reports should confirm the continuing Swiss recovery with both expected to produce positive comparisons to periods prior.  The franc remains our favorite major across the board on a fundamental basis as the Swiss economy outperforms its larger neighbors. With the general unrest in France it may attract safety of funds capital as well. The franc's only flaw is its low interest rate which makes it vulnerable to carry trades as the dollar rate continues to increase.

Boris Schlossberg is a Senior Currency Strategist at FXCM.