For Dollar NFP is Once Again Key
The battle between dollar bulls and dollar bears raged on for most of the week essentially resulting in a stalemate until Friday’s GDP report, which missed badly printing 2.5% versus 3.0% expected and sent the greenback sharply lower. For the week the unit lost 51 basis points against the euro but the ending price masked the fact that the dollar was higher for large part of the week.  The seesaw in price reflected the constantly changing market sentiment towards the probability of a Fed rate hike at the August 8th FOMC meeting  On Wednesday, the lackluster Beige Book sent fed funds futures reeling and greenback followed along with them with EUR/USD rallying to 1.2770. On Thursday however, the better than expected Durable Goods report put the idea of the rate hike back on the table and the greenback recovered nearly 100 points only to give it all back on Friday when the aforementioned GDP data dashed the hopes of dollar longs. The GDP news clearly showed a serious slowdown in consumption, but also more surprisingly a deceleration in business investment as well which certainly does not bode well for US growth going forward.

However,  the GDP news is hardly a slam dunk for dollar bears. The data tends to be backward looking and may therefore simply reflect the economic slowdown that has already occurred in Q2. More forward looking indicators such the Durable goods and the surprisingly buoyant Consumer sentiment readings  suggest  a possible rebound in demand.  The true state of affairs will only be revealed after next week’s NFP numbers. As long as job growth remains robust,  US economic demand is unlikely to falter. With wage price gains continuing to climb higher, as PCE – the Fed favorite measure of inflation - reached 12 year highs, the Fed may have little choice but to maintain its rate hike regime. On the other hand, should NFPs miss to the downside – game, set and match could well go dollar shorts.

Euro Looks to Dollar News
For the second week in a row euro traded at dollar’s mercy, producing very little volatility off Euro-zone economic news. The marquee event of the week – the IFO business sentiment survey - satisfied neither bulls nor bears as the report printed below the consensus estimate of 106.0 but above the whisper number of 103 registering a reading of 105.6 The latest sentiment gauge of the German business community suggested  that the Euro-zone recovery continued to maintain pace, but the high cost of energy and the prospect of new value added taxes in Germany, the region’s largest economy, due to take effect next year are tempering enthusiasm about future growth. Overall the IFO results basically reaffirmed the consensus view that the ECB will hike rates only once in  the month of August providing little additional fuel for euro longs.

Next week a slew of PMI reports in both Services and Manufacturing should provide the market with a clearer picture of the strength of the Euro-zone recovery.  The most interesting report however, should be the  German Retail Sales survey which has disappointed several months in a row. If the EZ consumer demand remains depressed the ECB will have a very hard time justifying rate hikes beyond the 25bp move planned for August 3rd. In order for Euro bulls to have a strong fundamental foundation for a sustained run, the market will need to see evidence that the EZ consumer is finally ready to spend money.

Yuan Reval Helps Yen
The much beleaguered yen bulls finally saw price action move their way as talk of yuan revaluation and strong Japanese employment data sparked a rally in the yen.  The USD/CNY exchange rate dropped to its lowest point since revaluation hitting the 7.97 level. Although Chinese monetary authorities squashed any talk of additional revaluation measures, the markets clearly anticipated further yuan strength, especially in light of China’s blazing 11% GDP growth in Q2.

Any strength in yuan of course helps the yen which acts a de facto proxy for the Chinese currency in FX markets. As we’ve noted before yuan strength helps Japanese economy in two ways. First it enhances Japan’s earnings in China which is its number one export market and secondly it makes Japanese products more competitive against its Chinese counterparts further stimulating Japanese export growth. 

In addition to reval speculation, the yen was boosted by strong employment results. Although the unemployment rate in Japan actually rose to 4.2% from 4.0% the month prior, the data reflected the fact that more people have re-entered the workforce  and is a positive sign of underlying economic strength. The more important job to applicant ratio rose to 1.08 the highest level in this decade. 

Next week brings Industrial Production and Manufacturing PMI data, both of which should reaffirm Japanese economic strength. The currency however is much more likely to trade off dollar interest rate hike speculation.  As long as Fed raises rates the yen is remains vulnerable to the carry trade, but once the Fed pauses the handicap of the low yielding yen will be minimized and the unit should begin to trade off its impressive economic fundamentals.

Rate Hike Potential Brings Pound Back
By midweek, it had appeared as though traders were abandoning Pounds in favor of Dollars, but the combination of a disappointing US Beige Book and hawkish words by the U.K. Treasury Minister helped push Cable up towards the previous Friday’s close of 1.8583.  On Thursday, Treasury Minister Ed Balls commented that there are considerable global economic instabilities and that they “undoubtedly carry risks for the economy going forward, including inflation risks”, while also noting that the MPC "is watching these things very closely".  Reaffirming the inflation concerns, economic data out of the UK has been quite positive lately, and with annual CPI well above the BoE’s 2.0% target at 2.5%, the markets are beginning to price in a rate hike of 25 basis points to 4.75% for the Bank’s MPC meeting next week on August 2-3. 

Last week’s economic calendar was fairly light, and the Pound’s reactions to the results were limited at best.  CBI Distributive Trades for July unexpectedly fell back to 7 from June’s reading of 9, as traders anticipated a rise to 10.  Despite this disappointing reading, spending has remained strong and looks to continue its growth throughout the quarter.  The CBI Industrial trends figure improved to -11 in July from -12 in June, reflecting the expansion of the industrial sector, however, the reading missed the forecast of -10.  Finally, UK mortgage lending figures for June remained near a two year high at £5.6 billion as approvals rose 5.9% following May’s decline of 6.5%, spurring concerns that the current environment may only be incubating the risk for a housing bubble. 

While next week is ripe with indicators, the BoE’s MPC meeting and subsequent rate announcement on Friday will be the predominant issue.  Speculation is mounting of rate hike, but the BoE is just as likely to wait until later in the year to follow through with an increase.  Manufacturing and services PMI are anticipated to decline, hurting the outlook for business growth, and housing prices are expected to rise again in July.  The data reflects a mixed bag for the UK, and Friday’s BoE verdict will be the deciding factor, as a hawkish decision by the BoE should please Cable bulls.

Stronger Data Could Persuade the Swissie and SNB
Similar to the Pound, the Swissie ended the week right where it began, despite impressive economic data.  The KOF leading indicator, one of the most important Swiss releases, jumped to a six year high of 2.61 in July, past the anticipated 2.56 and over June’s 2.50.  The stellar results highlight the massive expansion that has propelled Swiss GDP past that of  its much larger neighbor next door.  The UBS consumption indicator hit a five year high of 2.111, beating expectations of 1.920 and better than May’s upwardly revised 1.872.  The figure bodes well for already robust household spending in Switzerland, which has been encouraged by low unemployment numbers and mounting consumer sentiment.  Combined, these two remarkable releases could be the spark the SNB needs to continue their rate hikes throughout the rest of the year.  With two quarterly rates hikes already under their belt in 2006 and the possibility of a 2.00% target rate by year end may be just enough to give the Swissie the boost it needs from the near yearly lows its been wallowing in.

This week’s releases have the potential to sway the SNB the other way, as July’s CPI reading could fall 0.5%.  With the annual rate already below the SNB’s target of 2.0% at 1.6%, a drop in the monthly figure would dampen the prospects for a dramatic 50bp rate hike by the SNB in September.  The SVME PMI should hold at a solid reading of 64.0 in July, as manufacturers remain strong in a buoyant, accelerating economy despite shocking energy prices.  Despite the overwhelming evidence of a healthy Switzerland, traders may be more apt to pay attention to a diminishing CPI figure capping any upside potential of the Swissie.

Boris Schlossberg is a Senior Currency Strategist at FXCM.