US Dollar: The Start of Dollar Weakness?

So much for dollar bulls. The unit lost value across the board this week despite the hike by the Fed and continued good news from the Industrial Production and TICS reports. The Fed hike, though increasing the carry spread against the euro back to 200bp was viewed as dovish by the market, as the Fed communiqué left open the possibility of a pause after one more hike in late January of 2006. If that is indeed the case then the great dollar carry trade is over and the market may turn its attention to  the structural problems of US deficits where the picture this week was decidedly less rosy. The Trade deficit ballooned to an almost ridiculously high -68.9 Billion while the Current Account came in at -195.8 Billion. Although CA actually printed better than the gargantuan -205 Billion expectation, the only reason for improvement was the fact that foreign insurance companies settled massive US hurricane incurred claims, skewing the capital account - hardly a foundation for a long term cure. Ultimately the only reason the dollar did not see a more severe sell off was the massive surplus generated by the TICS number. At 106 Billion it more than offset the Trade Balance deficits. However, should that figure begin to contract dollar bulls will have true cause for worry.

Next week, one  final burst of data before the market slumbers into the holidays. Durable Goods, Personal Income and Spending will all be key to gauging if the red hot US economy continues to hum along.

Euro Holds Its Own

Second consecutive week of gains for the euro, though as we noted on Friday, “One of the key themes developing in the Euro-zone as we approach 2006 is the bifurcation of performance between Germany and France.  While the former is showing some promise and growth as political and economic reforms begin to take hold, the later appears to be mired in malaise as political upheaval and lackluster economic results plague the government in Paris.” On the German side both the ZEW and the IFO posted far better than expected readings with the former at 61.6  fully 20 points higher than expectations while the latter printed at 99.6 against 98.2 The IFO results were the best in 5 years as lower euro spurred export demand putting  smiles on faces of German industrialists for the first time in a long while.  France, however, continued to produce nothing but misery on the economic front as the Trade Balance ballooned to -2463 Billion euros and employment growth was non-existent  printing at 0.0% versus 0.1% expected. With most of the November data when the country went into a virtual lockdown due to riots, still not released, the news is unlikely to improve anytime soon.

Next week only a battery of second tier reports with Consumer Spending and New Industrial Orders perhaps most interesting for the market to analyze. Overall however, the euro story will most likely be dictated by trader sentiment towards the dollar

Yen: A Rush for the Exits

On Thursday we noted, “Virtually all parabolic moves in the markets are followed by sudden and vicious corrections and USD/JPY is no exception.”  Indeed. The unit gained 430 basis points on the greenback - the largest such weekly move in over 3 years. The eco data was generally supportive, but had virtually nothing to do with this massive collapse in the USD/JPY. The move was triggered by what the market interpreted as a dovish FOMC statement and the sudden  realization by every speculator Tokyo to Tacoma that the great dollar  carry trade may be coming to an end. The result? An unwinding of colossal proportions as every account  decided to liquidate positions all at once.  On December 5th we told Reuters that “(USD/JPY) is just so unbelievably overbought. The dealing community has had to get so long the yen because of this relentless rally that they will find an excuse... to push the yen temporarily lower.” And that apparently is what happened last week as dealers were only to happy to step away and let the pair collapse.

The question now however, is what happens next. As our partner noted on Thursday. “The (Japanese) government is completely unconcerned about yen weakness, but any whiff of yen strength and they start ringing the warning bells.  Last night, (MoF's Vice Finance Minister) Hosokawa said that the yen's move was “relatively big,” “excessive” and “undesirable.”  Although they are far from considering intervention to support USDJPY, it is a clear illustration of where their alliance stands.” The MOF rhetoric may produce some sort of short term bounce in USD/JPY, but last week's damage looks to be too severe and the pair may see more downside action ahead before finding a true bottom.

British Pound: Same Story Different Week

The pound registered the smallest gain against the dollar amongst all the majors. Rising 96 basis points on the week as the eco news continued to be mixed. LEI dropped to -0.3% against 0.3% projected and the Claimant Count rose to 10.5K from 8K projected while figure last month were revised higher to 13.5K from 12.1K originally reported. The news suggests that the vaunted UK jobs engine may be beginning to sputter which could mean far bleaker days ahead. On the bright side Retail Sales perked up 0.7% vs. 0.3% expected indicating that consumer spending while hardly buoyant may have stabilized which should be positive for the Christmas shopping season and the retail sector overall.

Next week only the CBI Distributive Trades survey and the GDP figures will attract any significant attention, though the RICS house survey if it prints at major variance either way could have some impact as well. In general. It appears that cable hit a ceiling around the 1.7800 level and only serious dollar bearishness is likely to clear that resistance for the unit.

Swiss Franc: Rate Hike But Rhetoric Spike

As expected the SNB raised the repo rate to 1.00% this week, but the real story for the Swissie were the decidedly dovish comments by SNB chairman Jean-Pierre Roth who first noted that “The moderate increase in the interest rate is compatible with our strategy of making gradual corrections to a very expansionary monetary policy, “ only to add, “If the Swiss franc were to appreciate rapidly, the SNB will react accordingly.” Offering a thinly veiled threat to the market that the Bank will do everything in it's power to ensure that the export led growth of the last six months is not damaged. As a result, traders backed off their bid and  EUR/CHF actually gained on the week as market participants reconsidered the possibility of future SNB hikes despite the apparent growth differentials between Switzerland and EU.

Boris Schlossberg is a Senior Currency Strategist at FXCM.