US Dollar
Today’s US economic reports told us a lot about nothing.  There were signs of weakness even in the stronger releases which explains why the dollar gave back some if its earlier gains against the Euro.  Today’s news leans us ever so closer to the possibility of an interest rate cut by the Federal Reserve.  The PCE deflator and the Chicago PMI prices paid index sent mixed messages about the state of inflation with the earlier reflecting faster inflationary pressures and the latter reporting a drop in prices.  Federal Reserve President Poole cleared the confusion by saying that “the worst of the inflation news is now behind us.”   As a voting member of the FOMC beginning with the meeting on October 24th, Poole’s dovish words are important to listen to.  In addition to the prices paid component of the Chicago manufacturing report, the employment index also dropped over 4 points, the largest since April.  The deterioration in these two indices offset any optimism that came from the jump in the headline number from 57.1 to 62.1.  Yet the most worrisome part of the release was the sharp rise in inventories.  Some could argue that the rise in inventories is in anticipation of future demand, but given the state of the US economy, we suspect that the highest reading in over 20 years is more of a problem than anything else.  If demand does not meet up to production in the winter months, we could see a sharp cut back in activity.  In regards to the other releases this today, personal spending grew by only 0.1 percent, the weakest pace since November 2005.  Income printed in line, but that too slowed for the second month in a row.  Although these numbers are from August and we should really be looking at September data (retail sales is not due until 10/13) for an updated take on how the economy is doing, it nevertheless does suggests that US consumers are beginning to buckle under the weight of the housing market.  Hopefully next week the data that will be released will not be as grim.  The most important numbers that we are expecting are ISM and non-farm payrolls.  Federal Reserve Chairman Bernanke will also be speaking to the Economic Club of Washington on Wednesday about savings.  Bernanke will probably stick to topic though a talk about savings may necessitate a comment on the behavior of consumers.  With currency pairs stuck in a tight trading range, NFP tends to have the power to cause breakout moves in the FX markets, the hope is that it will do so next week when the fourth quarter officially begins. 

Euro
Over the past week, there has been further evidence that we will probably see only one instead of two interest rate hikes from the European Central bank by year’s end.  Not only did future expectations of business confidence take a big tumble in Germany, but we now learned that businesses have good reason to be less optimistic about the future as German retail sales stagnated in the month of August. Inflationary pressures have been falling globally and according to the flash estimate for Eurozone CPI, annualized inflation is now below the ECB’s 2 percent target.  The September figure fell from 2.3 percent to 1.8 percent, led primarily by the decline in oil.  With the ECB’s primary concern being inflation, the decline could allow the ECB to leave monetary policy a tad more accommodative, which Germany may need when the VAT tax is increased next year.  So far, the Eurozone economy is still holding up well, so one more rate hike would not be overdoing it.  ECB member Weber has already said that the economy will benefit from lower oil prices.  In the week ahead, we are expecting manufacturing, service and retail PMI reports.  None of these releases should offer much surprise so we can only hope that US data will take the EUR/USD out of its recent ranges.  We want to continue to point out that even though the Euro lost ground against the dollar, it rallied against the Japanese Yen, British pound, Swiss Franc, Canadian and Australian dollars.  The crosses are seeing far more action than the majors recently and unless we get a shocking US number, this will probably remain the case. 

British Pound
Over this past week, the British pound has seen its longest stretch of weakness against the dollar since December.  Despite a US session recovery, the British pound ended the day lower against both the Euro and US dollar.  Consumer confidence ticked higher from -8 to -7 but the housing market figures showed a decrease from the prior month with mortgage approvals and net lending numbers falling short of expectations.  We are not worried about the housing market since many other reports have signaled strength, but the downward revision to inflation figures reported yesterday is still having an impact on the markets.  In the week ahead, we are expecting more housing related data, in addition to manufacturing sector PMI, retail sales, industrial production and a Bank of England monetary policy meeting.  After the ONS revision, we do not expect any interest rate changes by the BoE anytime soon. 

Japanese Yen
Mixed Japanese economic data released overnight has led to a sell-off in the Japanese Yen against non-commodity currencies.  Both industrial production and household spending came out short of expectations, but consumer prices accelerated from the previous month.  Many of the Japanese Yen crosses are reaching key resistance levels while the commodity linked yen crosses are already beginning to turn.  Whether we see the Yen be able to begin to register gains will be partially dependent upon Sunday’s quarterly Tankan measure of business sentiment.  The Ministry of Finance has already suggested that the survey may be very strong, but with the reading already sitting at lofty levels, it will be difficult to see much further strength.  Despite signs of weaker growth in the Japanese economy, the drop in oil prices and the weak yen could make businesses more optimistic.  If the Tankan comes out strongly, we could see a major turn in the yen.  If not, expect fresh highs in USD/JPY and EUR/JPY.

Kathy Lien is the Chief Currency Strategist at FXCM.