US Dollar: the Moment of Truth

The currency market for all intents and purposes was closed from Wednesday on as combination of Passover and Easter holidays shut off order flow to a trickle. US data was surprisingly resilient with every major release beating expectations. Most impressive was the continued increase in Retail Sales as higher oil prices and higher interest rates left no discernable impact on the US consumer. Sales advanced 0.6% versus projections of a 0.4% rise and suggest that GDP in Q1 of 2006 should register a healthy rate of growth.

Despite the green on the screen the dollar lost ground against all  the majors save the yen as traders looked past the eco news to next Mondayâ�,��"�s TIC report. As we wrote in our Friday note, â�,��"Focus will soon turn to Mondayâ�,��"�s TICs report which could show the third consecutive month of foreign capital inflows failing to offset the Trade deficit gap. Worries about the structural problems of the US Balance sheet may weigh on the pair as FX dealing slows to a crawl heading into the holiday.â�,� In addition to TIC data, the currency markets will also watch the housing releases projected to slow down from the period prior. If the housing reports miss strongly to the downside, the dollar which has been very sensitive to housing news lately, may take a tumble as well.

Euro: Support?

What was most impressive about euro price action was the fact that the currency managed to eke out a 9 basis point gain despite producing nothing but misses all week long. Foremost on the plate was the decline in ZEW readings from 65.5 expected to 62.7. But as we wrote on Tuesday â�,��"â�,�¦ the headline number masked a huge improvement in the current situation component which went from -8.4 in March to positive 2.9 this month. Overall the two readings essentially offset each other and the impact on the pair was mild at least in the European trade as EUR/USD lost only 20 points off the high of the day.â�,�

As the week wore on it became increasingly clear that despite the poor French Industrial Production showing, the tepid ZEW and the muted German CPI numbers, the euro enjoyed strong support anywhere near the 1.2050 region. The source if this demand very likely came from Central Banks looking to diversify their reserves whenever the pair drops to within the 1.2000 level. This has been the primary reason for euro strength as the unit continues to act as the anti-dollar rather than trade on its own fundamentals.

Next week this trend is likely to continue as the Euro-zone calendar is essentially barren of any top-tier data. Only French Consumer Spending may send a ripple through the market. For the most part EUR/USD price action will be dominated by US economic news.

ZIRP Hurts the Yen

Once again the yen underperformed, losing 34 basis points to the dollar while all other majors gained in value. The losses certainly couldnâ�,��"�t be blamed on economic performance which continued to expand at a torrid pace with Machine Orders jumping 3.4% against 3.2% expected. Additionally, Japanese economic expansion is finally filtering to the consumer sector as our favorite gauge of consumer sentiment â�,�“ the everyman Eco Watcher Survey â�,�“ jumped to 57.3, the highest reading in more than 6 years. 

Yet events that drove yen trading last week had little to do with economic data. The BOJ board meeting concluded anticlimactically for any yen bull looking for a quick abandonment of ZIRP.  We wrote Tuesday, â�,��"In Japan, the BOJ meeting ended without much fanfare and much to the disappointment of yen longs, Governor Fukui refused to signal any expedited timetable for the removal of the Zero Interest Rate Policy. Mr. Fukui only noted that the BOJ is reducing the current account balances at an acceptable pace and appeared comfortable with the Central Bankâ�,��"�s gradualist approach to monetary tightening. In short the market now expects that Japanese monetary authorities will not move any faster than July before considering a rate hike and that news stoked the interest of carry traders who plowed into the pair once again driving it towards the 119.00 figure.â�,�  That fact followed by a much more restrained CGPI number which printed 0.0% versus 0.2% expected put the kibosh on any hopes of an early move by the BOJ and thus the yen continued to struggle against both the greenback and the euro.

Surprise of Cable Rise

By far the biggest surprise of the week was the price action in the pound which saw the unit register the biggest gains against the greenback amongst all of the majors. The rise was especially unexpected since the UK unemployment data displayed another month of weakness rising by 12.6K new claimants instead of 6.5K expected.  Yet the market chose to ignore the news focusing instead on the large quarterly wage gains which rose 4.2% against 3.6% projected.

Calyonâ�,��"�s  Daragh Maher, commenting on the price action in the pound this week, noted, â�,��"The currency has â�,�¦ benefited from corporate news flow, including NASDAQâ�,��"�s purchase of a stake in the London Stock Exchange â�,�¦ All of this provides a comforting after-the-fact rationalization for GBPâ�,��"�s recovery, but none of it gives particular reassurance that it might continue. The positive impulse from M&A announcements are fleeting, and barring additional stories of this type, their influence will fade.â�,� We tend to agree.

Next week brings only a smattering of housing data as well as CPI news later in the week. Only if the CPI news is inordinately high to the upside â�,�“ a prospect we doubt will occur given the lackluster nature of consumer demand â�,�“ will the pound feel a material impact to the upside. Otherwise the currency is likely to settle down and trade off the US news flow as the M&A activity fueled rise runs out of steam.

No News Favors the Swiss Franc

Franc continued to perform well this week in an absolute vacuum of news gaining 22 basis points on the dollar and rising against the euro for the second consecutive week. Last week we noted that â�,��"With absolutely no economic data this week, the Swissie will likely trade off the Euro-zone news, most specifically Tuesdayâ�,��"�s ZEW survey. If that measure of EZ investment sentiment surprises to the downside once again, the EUR/CHF cross could test the 1.5700 figure as euros rate fueled rally will continue to unwind.â�,� That indeed is what occurred in the Swissie as pared down EZ rate expectations continued to favor the franc. Yet the unit remains vulnerable to carry trade flows as its ultra low interest rate is unlikely to be rise much given the muted inflation present in the Swiss economy.

Next week, Producer and Import prices may stir some excitement if the number prints materially larger than the 0.3% expected as the potential of higher energy costs could lead to an upward surprise. Additionally if Retail Sales show yet another strong gain the pressure on the SNB to stop being so lackadaisical about monetary policy will likely increase.

Boris Schlossberg is a Senior Currency Strategist at FXCM.