US Dollar Testing Support

One can hardly call last weekâ�,��"�s news unequivocally positive but it was good enough to rally the dollar for another 66 basis points against the euro. The key driver for the week was the still hawkish Fed which gave all indications to got to 4.75% in March and possibly 5% money by the summer. The news brought out the carry traders in droves as they jockeyed for positions to benefit from further yield increases.

Yet the news from the â�,��"realâ�,� economy was not nearly as sanguine. NFPs missed their mark of 250K by printing at 193K, but were close enough to the magic 200K number to assuage the market.  EUR/USD quickly spiked and then collapsed below 1.2000 after the release of the data. Still the data last week printed enough red surprises to stitch the Chinese national flag. Most troubling of all was the divergence between NFPs and the employment component of the ISM Services report which dropped by 5.8 points to hover just above the 50 boom/bust level.

In light of last weekâ�,��"�s poor GDP showing the data appears to be indicating an inevitable US economic slowdown. That realization may finally strike the FX market as it begins to re-price that possibility into exchange rates. While the EUR/USD did plummet through the 1.2000 level it managed to bounce back above by end of day Friday.  As long as 1.1950 holds the play may be to the euroâ�,��"�s side as this week unfolds.

Euro: Show Me the Money

So, the export sector is booming. Factory orders are up and a variety of surveys show increased optimism. Yet despite the seemingly firm economic back drop, consumers are not spending money.  More than any other release last week, the sudden and totally unexpected decline in German Retail Sales to â�,�“0.8%  was responsible for euroâ�,��"�s weakness. Furthermore German unemployment climbed to 11.3% from 11.2% as continuing structural adjustments to the data  sent more workers to the rolls. As we noted in commentary on Wednesday, â�,�The latest economic data is likely to exert strong political pressure on Mr. Trichet to hold off on a March hike by various eurozone finance ministers gravely concerned about the unemployment situation in their respective countries.â�,�

So far Mr. Trichet appeared unfazed by last weekâ�,��"�s news as his rhetoric clearly suggested that a hike was on the agenda come March. Next week, the Retail PMI numbers may provide more clues to the strength of the EZ recovery, yet the message of last weekâ�,��"�s data  is that export growth can only take the EZ so far. Until the region develops some organic consumer demand, the recovery is likely to be sluggish and so will any rally in the EUR/USD. 

Carry Kills the Yen

For the second consecutive week the yen was the worst performer amongst the major losing 135 basis point to the greenback. USD/JPY smashed through the 118.00 but couldnâ�,��"�t quite clear the 119.00 figure before ending at 118.86 for the week.  Japanese economic data was actually relatively firm with the key Workers Household Spending numbers printing in line â�,�“ up 0.4% month over month. This was the second month out of three that this series showed positive results, suggesting that Japanese consumer spending is gaining traction. In addition jobless rate dipped back to 4.4% with workers to employment ratio reaching 1.

Nevertheless the yen was pummeled in the market by a combination of  a hawkish FOMC rhetoric and dovish BOJ statements. BOJ deputy Muto stated that any decision on removal of the Zero Interest Rate Policy was months off, pouring cold water on the hopes of many yen bulls expecting sooner action.  USD/JPY continues to trade primarily off interest differentials and until that theme plays out is likely to see sharp spikes followed by vicious declines as spec capital moves in and out of the pair.

British Pound: More Rate Cuts Ahead?

On a relatively basis, the pound fared extremely well against the dollar for most of the week boosted by surprisingly firm eco data. Both PMI Services and PMI Manufacturing increased and consumer confidence improved markedly. However on Friday sterling roped nearly 200 points in the wake of the NFPâ�,��"�s and then did not recover at all. The culprit? Rumors on the dealing desks that Sunday Times was about to run an article suggesting 2 rates cuts ahead in 2006.

BOE may indeed cut rates as the year proceeds but last weekâ�,��"�s eco news validated its wait and see attitude and given the strength of the data, it unlikely that the Central Bank will loosen monetary policy anytime soon. The key this week will be the Manufacturing and Industrial Production data. That sector has been the weakest in the UK economy and if it shows signs of stabilization the BOE will have more room to keep rates unchanged. However, if the data shows another month of contraction the pressure on the bank to cut will become immense and the pound bears who took the unit down last week may well have been correct..

Swiss Franc Treads Water

The Swissie continued to lose ground against the greenback this week losing 35 basis points before finally stalling out at 1.3000 figure. The eco data proved to be non event with PMI edging up slightly while the Trade Balance surplus contracted a bit to .51 Billion from .76 Billion the month prior. More surprising was the relative apathy by the FX market over the brewing global confrontation with Iran. The 35-member IAEA board of governors voted on Saturday by a clear majority to refer Iraq's nuclear program to the UN Security Council raising the stakes in the conflict and possibly leading to economic sanctions and a significant confrontation in the region.  Tensions between the West and Moslem countries were also inflamed by the side issue of  editorial cartoons that appeared in many European papers that many Moslems found insulting to their religion.

Despite the swirling anger the swissie attracted little interest as the market continued to believe that the present conflict amounted to nothing more than saber rattling. Whether such equanimity was appropriate remains to be seen.  Certainly no immediate results are likely from the IAEA action as the Security Council is not expected to take up the matter until at least March.  However, should the USD/CHF progress to the 1.3200 region dollar bulls may well grow cautious as the pair would hit overhead resistance right at the same time a geopolitical risks  could suddenly become quite real.

Boris Schlossberg is a Senior Currency Strategist at FXCM.