US Dollar: NFP is Key

Suddenly the picture is not so bright and sunny for dollar bulls. Confidence in the American dream is sinking despite generally positive ISM results that demonstrated both manufacturing and service sectors are humming along well above the 50 boom/bust levels. Despite that fact both Consumer Confidence Board and the U of M surveys showed large drops in consumer sentiment with the former falling to 101.7 from 106.8 in January and the later registering an 86.7 reading down from 87.5 the month prior.  The feeling of foreboding pervaded the US consumer, perhaps spurred by the news that existing home sales fell for the fifth consecutive month and the great housing ATM which has served as the one true source of income at a time when wages growth has been stagnant, is finally running out of cash. Add to that mix gasoline inching towards the $3/gallon price point as oil trades at $64/bbl and its understandable why the US consumer is skittish.

Demand for housing, as many analysts point out, is driven by a strong employment market. Thatâ�,��"�s why this weekâ�,��"�s Non Farm Payrolls may be even more significant to the health of the greenback than usual. The 200K barrier remains key to the US growth scenario and in turn to higher Fed funds rates which will be necessary to support the buck.

Ahead of the NFPâ�,��"�s the Trade Balance numbers are expected to widen to â�,�“$66.5 Billion dollars while last week also brought news that for the first five months of fiscal year 2006, US national debt increased a record $337.2 Billion to $8.27 Trillion quickly approaching the here-to-unimaginable $10 Trillion barrier.  In short, it appears that the USD long positions have tremendous headwinds against them but, if the NFP surprise to the upside those positions may yet be rewarded.

Euro! Euro! Euro!

The momentum has been building for weeks with EZ eco data printing better than expected results for almost a month. This week was no exception as signs of a rebound in the region continued to mount, Most impressive of all was the jump German Retail Sales which rose 2.7% versus 1.0% expected, suggesting that the long dormant European consumer may be finally ready to contribute to growth. The strong performance of the unit was enhanced by the hawkish statement from ECB which raised rates by 25bp to 2.50% and promised to be â�,��"vigilantâ�,� in fighting inflation.

The news was good enough to push the euro higher by 142 basis points and clear the 1.2000 figure for the first time in more than a month. The single currency may see further strength at the beginning of next week if the Retail PMI number confirm last weekâ�,��"�s strong German Retail Sales, but afterward trading is likely to be influenced by US data. Still, with most economic data looking more positive, this is the first time in a long time that the euro may be attracting interest on its own merits rather than  simply as an anti-dollar instrument.

Yen: Not Quite There

On Friday we wrote,â�,� In Asia, the news was not nearly as friendly to yen longs at USD/JPY verticalized more that 100 points after the announcement of Japanese CPI data. The report did show that prices registered a third consecutive month of gains but the rise was a bit more contained than the market anticipated, with Tokyo CPI rising only 0.1% vs. 0.2% projected. Furthermore, Household Spending came in woefully weak  as consumption declined -4.7% vs. -1.4% expected indicating that the Japanese consumer is not yet ready to participate in the recovery with wages gains remaining problematic.  The net effect of all this news was to push off expectations of any QEP tightening to April rather than March as BOJ will likely need another month worth of data to initiate any policy change.â�,�

For the week the yen barely managed to squeeze out a gain climbing a mere 41 basis points against the buck. Talk of QEP tightening may have been premature. That and the fact that the Japanese authorities looked askew at the USD/JPY dropping through the 115.00 level which would impact the vital export sector helped fuel a short covering rally in the pair. Next week the Eco Watchers survey will be a key tell of Japanese consumer sentiment. If the reading drops below the critical 50 boom/bust level the yen may see further weakness as carry trade speculators would likely plow back into the pair on expectations that ZIRP is not going away just yet.

British Pound Keeps Its Cool

Though it only managed to muster a 56bp rise against the greenback this week, cable showed resiliency rebounding strongly on Friday after dropping deep below the 7500 figure in Thursday trade.  Most the weakness in the currency was technical in nature as a very large buy order in EUR/GBP from a Spanish bank kept the unit pinned down while the euro rallied.

On the economic front, the data was generally supportive with Services PMI registering an impressive 58.9 reading up from 57 the month prior. The broad consensus in the market is that BOE stays put with traders expecting no change in the 4.5% repo rate after the MPC meeting this Thursday. Thursday will also bring news of Manufacturing and Industrial Production as well as the Trade Balance promising to be the day with greatest amount of event risk for sterling next week. The market is not looking for any dramatic change and the pound may well tread water here, reacting more to US news rather than its own. The unit does not have any meaningful resistance until the 1.7800 barrier, so if the anti-dollar sentiment continues pound bulls have room to go.

Swiss Franc Shows Strength

After nearly a month of superlative economic results but relative underperformance in price, the Swissie finally showed some strength last week rising the most against the dollar amongst all the majors.  The issue of interest rate differential may continue to weigh on the unit, but if the economic data continues to demonstrate excellent results such as last weekâ�,��"�s reading of 60 in the SVME PMI survey, the SNB will be hard pressed to keep rates at 1%.

One report that may budge the Central Bank to be more hawkish will be the CPI data due out next Thursday. The report is expected to  print a gain of just 0.1%, however, if the results are actually stronger, the market will begin to price in a rate hike in the March meeting. The EUR/CHF having reached a peak of 1.5675 finally traded down to 5610 by end of Fridayâ�,��"� session. If the Swiss strength persists the cross may see more weakness in weeks ahead.

Boris Schlossberg is a Senior Currency Strategist at FXCM.