US Dollar: Is It Broken Yet?

Economist Herb Stein, chairman of the Council of Economic Advisers during the Nixon administration, used to say: "Things that can't go on forever, don't." Is the Housing market about to be subject to Steinâ�,��"�s law? Certainly data from last week was less the encouraging for dollar bulls as both Housing Starts and Building Permits both dropped below expectations. 6% money and $2.50/gallon gasoline could be putting an end to the Real Estate ATM. Why do we keep harping about this subject practically every week? Because for all intents and purposes Housing is the US economy these days. It is responsible not only for the vast majority of the nationâ�,��"�s wealth creation since 2001 but also its marginal income, as US consumers in the absence of  meaningful wage gains resorted to tapping their home equity loans to the tune of nearly 1 Trillion dollars in 2005. So if housing declines its very difficult to see how the dollar would not follow. It may happen of course â�,�“ the FX market can always surprise you â�,�“ but for now we think this may be the key story to follow as 2006 begins to take shape.

To that end, this weekâ�,��"�s Existing Home Sales data doesnâ�,��"�t appear to hold much promise for dollar longs as it is predicted to contract slightly from Novemberâ�,��"�s readings. In fact looking at next weekâ�,��"�s calendar the numbers are all red suggesting that the greenback may be in for beating. The EUR/USD impressively held the 1.2050 level all week long and a sustained break above 1.2150 mark could open up a run to the 2300-2400 zone. However if we tumble 1.2000 all bets are off and the pair could target the range lows once again.

Euro on the Cusp

A relatively quiet data week in the Euro-zone that showed a generally bullish tone to most of the reports. European Industrial Production rose 1.30% versus 1.00% expected on the back of healthy export growth out of Germany. On a sour note French spending collapsed -1.0% against expectations of 0.3% rise. As we wrote on Friday  â�,��"The regionâ�,��"�s second largest economy continued to struggle and remains the weakest link in the EZ recovery story.â�,� France really does remain the central problem for EZ and if her economy remains in a quagmire, it will act as damper on any possible EUR/USD move upward.

The pair, however, shrugged off most of the eco data and rallied at the end of the week on the news that Iran was liquidating its dollar reserves. Iran remains the true wildcard on the global scene. It is still unclear whether Mr. Ahmadinejad is simply playing a dangerous game of brinkmanship or intends to really take the country to the point of confrontation. Over the week-end Israel already put Iran on notice that it will not tolerate any nuclear weapons on Iranian soil ratcheting the tension even further.

Next week all EZ data is projected to be green, but even if the region suffers some negative surprises the momentum generated by the geo-political conflict may push the unit higher.

Yen Vulnerable

The yen declined against the greenback this week putting in the weakest performance amongst the majors dropping 80 points. The data continued to paint a mixed picture as Current Account and Trade Balance both came up short and Consumer confidence declined for the first time in three months. On the flip side both IP and Capacity Utilization edged higher. The overall message from the eco data was that Japanâ�,��"�s recovery continues albeit at a les torrid pace than the market expected.  The unit finds itself at a key inflection point between the yen bulls who see further growth and possible yuan revaluation leading to more carry trade liquidation and yen bears who now view the correction over and forecast further carry trade pressure as US rates climb to 4.5% while BOJ maintains its ZIRP stance throughout 2006.

Next week the front of the week may see more pressure on the currency as Tertiary Activity Index is expected to slow, but the key report of the week will come Thursday night when Retail Trade results are reported. Healthy consumer spending growth is the key to any tightening move by BOJ and if that report disappoints the yen is likely to suffer further losses especially against the high yield crosses.

Rally in the British Pound

It's all how you view it. Unemployment rate poked through the 5% barrier. PPI output prices dropped â�,�“0.2% suggesting that inflationary pressures were non-existent. Yet the pound managed to eke out a gain picking up 35 basis points on the week. Why? Retail Sales. The report printed 0.4% versus 0.4% expected but on a year over year basis the number actually showed better than expected 4.0% gain. The news sparked a rally in cable, as traders interpreted the numbers to mean that the retrenchment in UK consumption â�,�“ the key factor in BOE monetary policy decision making process â�,�“ may have finally run its course. If UK consumer spending does stabilize, BOE rate cuts become  increasingly unlikely, stoking further bullish sentiment in the pound.

Next week GDP and BOE Minutes will be the prime focus of most traders and analysts. Specifically, market players will want to know more about individual MPC members read of the data to understand if the doves are beginning to take the upper hand in the policy process.

Iran Worries Help the Swiss Franc

A quiet week on the economic front for Switzerland but the unit received a boost late Friday from reports that Iran was considering moving its $50 Billion in reserves out of European banks into Swiss banks as a preemptive measure against possible sanctions from EU and US.

Next week the focus turns back to economics as both UBS Consumption indicator and the KOF index  are on the calendar. The KOF is expected to reach 1.43 which would be the highest reading in 5 years and sure to fuel speculation of an additional SNB rate hike. Should the number disappoint however, the franc may be due for a sharp correction as the markets expectation of Swiss growth have become progressively more optimistic in the last few months and any failure to meet the forecast could see some capital outflow from the franc.

The economic arguments may be moot however, if the Iran situation escalates further next week. If no diplomatic solution seems forthcoming, the Swissie will act as the traditional safe haven store of values with political considerations trumping any eco results.

Boris Schlossberg is a Senior Currency Strategist at FXCM.