Dollar Wins as Commodities Lose
Oil down. Gold down. Metals down. Little wonder then that the dollar finally managed to stage a rally rising against all the majors for the first week in five. Ironically enough, the fundamental data was anything but rosy with TICS falling short, housing showing further weakness and Empire Manufacturing signaling a serious slowdown in demand. Yet the market chose to ignore the news focusing instead on the robust inflation readings which have now led many players to speculate that the Fed will not have the luxury of pausing in June, pushing interest rates above the 5% level.

With the unit so grossly oversold against the majors a rally was due. In fact on Monday of last week we stated that, "euro/dollar rally may have set a top for the time being," and that appears to have been the case.

This week dollar longs may be able to push their luck if Housing data and more importantly GDP revisions all print higher. Lower oil prices will also help greatly. For greenback bulls, US growth remains the key to their argument. If the slowdown in demand is perceived as only temporary the dollar rally may have legs, but if we are now entering the worst of both worlds â�,�“ higher prices and slowing demand, the buck will be in trouble. Continued growth or the start of stagflation? That will be key question driving the FX market this summer.

Euro Hitting a Wall
After rising against the greenback for an unprecedented 19 out of 20 sessions over the past month, the euro finally took a breather dropping 120 basis points against the dollar for the week. The seminal event that drove the unit lower was the sharp decline in the ZEW readings as higher exchange rates are clearly starting weigh on sentiment of EZ investors. The region has managed to stage a very fragile recovery on the back of the export sector but the stronger euro threatens to prematurely snuff out any chance for growth.

At the same time the unnaturally low rates in the region (at 2.5% the Eurozone short term paper trades at 250 basis points less than the US equivalent) along with stubbornly high oil prices have raised inflationary alarms amongst the ECB officials. Thus we have the familiar conflict between European monetary authorities who have consistently issued hawkish statements and European fiscal officials such as France Finance Minister, Thierry Breton who noted last week, that he will do â�,��"everything to keep the Euro from appreciating further.â�,�

Mr. Bretonâ�,��"�s wishes may come true next week if either German Retail Sales or the IFO report fail to meet expectations. Both of these pieces of data remain critical to the strength of the euro bull thesis. If German economy is truly in the midst of recovery, consumer spending must rise. So far, Retail Sales proved a severe disappointment over the past few months. If Aprilâ�,��"�s figures do not turn the tide and if IFO much like ZEW falls on worries over exchange rates, the retrace of the euro rally could accelerate.

110 Proves Too Much for Yen
Last week we wrote, â�,��"For the first time in years they (Japanese authorities) have hinted at the possibility of intervention and if the stronger yen begins to ruin the profit margin of the country's vital export sector, those hints may turn into action.â�,� While threats of intervention did not materialize, Japanese officials did the next best thing â�,�“ by hinting that ZIRP would stay in place longer than the market expected. After moving relentless lower for most of the week, nearly breaking the 109 figure, USD/JPY finally verticalized on Friday as traders slowly realized that zero interest rates may stay in place far beyond the month of June. The short covering rally was quick and vicious with the pair reaching 112.26 despite generally good news on the economic front with Japanese GDP rising 1.9% versus 1.1% expected. But with so much positive economic data already baked into the price of the pair, speculation turned back to interest rate differentials.

With USD/JPY now holding a negative 500 basis point spread for anyone long the yen, the cost of maintaining such a position for a long time becomes prohibitively expensive for most speculators. Thus, once the pair stopped moving their way, yen bulls quickly covered their USD/JPY shorts exacerbating the rise in the pair.

Although Tertiary Industry Index may offer some trading possibilities next week, the true focus of traders will no doubt be centered on the Japanese inflation data due out on Thursday night. If, as the market expects, price levels have risen by 0.5% on a year over a year basis, then the BOJ may not have the luxury of delaying the lifting of ZIRP. However, if inflation data proves muted, the greenback could easily gain further ground against the yen as attention will once again turn to the carry trade.

British Pound Getting Ahead of Itself
1.9000 figure just proved too much for the pound this week as the unit came off those levels after repeated attempts to break the highs. Cable was hampered by smaller then expected gains in LEI and continuing deterioration in employment with jobless claims once again rising above forecast. On the flip side Retail Sales perked up to 0.6% from 0.5% expected suggesting that the UK consumer remains alive and well. Housing data was also positive with RICS jumping to 15% - its second best showing this year. Overall sterling did indeed decline, but its correction was the shallowest amongst the majors.

The pivotal event last week was the release of BOE minutes which disclosed a surprising 6-1-1 vote with David Walton voting for a rate hike. As we noted on Thursday, â�,��"Walton was one of the members to vote for a rate cut during last June's MPC meeting; thus his conversion to a hawk held special significance to the marketâ�,�¦as traders now perceive the odds of a U.K. rate hike to be far higher than those of rate cut.â�,�

Next week the UK economic calendar is very light with only the Industrial Trends survey and GDP data on tap. The unit is far more likely to trade off US news rather than its own and given its enormous rally over the past few weeks may see additional correction ahead.

Swissie Retreats
Although the little data Swiss data that appeared on the calendar was positive, the franc suffered the sharpest retreat against the greenback amongst all the majors falling 152 basis points for the week. Part of the reason for the fall was the easing of geopolitical tensions as the conflict with Iran appeared to have cooled for the time being. The strong sell off in gold also helped to depress the Swissie.

The upcoming week holds a lot more news for the franc with Retail Sales and Trade Balance data on tap. If Retail Spending continues to post impressive year over year gains, traders may begin to price in quarterly SNB rate hikes for the rest of the year. As weâ�,��"�ve noted many times in the past, Switzerland continues to perform far better than its far larger neighbor next door and is likely to weather the higher exchange rates with less impact to its growth rate. If the data this week proves as robust as all other recent economic indicators, the retreat in the Swissie may be quite temporary especially on the crosses.

Boris Schlossberg is a Senior Currency Strategist at FXCM.