How Real Is Dollar Rally?
It was a market that only central bankers could love as EUR/USD traded a few points of either side of 1.2700 until Fridayâ�,��"�s NFP results, producing more volatility in one hour than happened during the whole week.  However, much like most of the economic date lately, the NFP results were hardly crystal clear. The monthly job number printed at only 51K woefully short of 120K consensus estimate, but the month prior was revised sharply higher to 188K from 120K initially reported. Furthermore, in a preliminary estimate, the Labor Department said payrolls for the 12 months ended in March 2006 will be revised higher by 810,000, the biggest revision since the Labor Department started benchmarking numbers in 1991 and fully 45% higher than initial estimates.  So is this bullish for the dollar? Perhaps. Job creation may indeed be generating enough income to offset the depressive effects of the slowdown in housing but in the inimitable worlds of Raul Julia in The Gumball Rally, â�,��"Whats-a-behind-me does not matterâ�,�. The BLS revisions point to past economic strength whereas Septemberâ�,�˜s tepid results could be signaling weakness ahead.  As we noted on Friday,  jobs in the US economy with its 4.6% unemployment rate are not the real issue: Income is. With average US household debt rising to 130% of income, debt service is likely to consume a progressively bigger share of US consumers monthly budget dampening future consumption. Although wages grew 4.0% on year over year basis â�,�“ their best performance in 5 years â�,�“ the monthly gain was only 0.2% versus 0.3% expected, providing little fuel to spark a consumption boom. Given current US economic fundamentals we remain dubious that the dollar rally will be able to continue much beyond the 1.2500 level.

Next week the two key reports for dollar traders will be the Trade Balance and the Advanced Retail Sales numbers.  According to latest data from Long Beach and Los Angeles ports, imports have increased at a whopping 16% rate versus past levels of 12% suggesting the trade gap may hit another record unless lower oil prices offset some of that growth.  As for Retail Sales they will tell the true story of the strength of the consumer and will bear watching closely.

Euro - Slow But Still Steady
From Mr. Trichetâ�,��"�s always entertaining post announcement press conference this week, it seems clear that the ECB is headed for 3.5% by yearâ�,��"�s end. After having raised rates by another 25bp on Thursday to 3.25%, Mr. Trichet downplayed the latest declines in headline inflation numbers, even suggesting that they will rebound, and essentially telegraphed to the market that the ECB intends to tighten further in order reign in what it sees as ample liquidity in the system. So, with interest differential between the euro and the greenback possibly tightening to just 200 basis points â�,�“ why did the EUR/USD drop on the news? Perhaps, it was Mr. Trichetâ�,��"�s rather dour outlook on 2007, which he suggested would see a material slowdown in EZ growth hampered by rebounding energy prices.  For the time being, however, Mr. Trichetâ�,��"�s pessimism is not borne out by the data. All of the PMI indices reported well above the boom/bust level of 50 slipping only slightly from prior peaks. Retail Sales improved an acceptable 0.7% on month over month basis and perhaps most surprising of all Factory Orders jumped 3.7% versus â�,�“0.4% projected as EZ industrial sector was unaffected by euroâ�,��"�s Q3 strength against the dollar and especially the yen.

Next week the Euro-zone calendar is relatively quiet with most of the important data scheduled for the front of the week.  On Monday traders will focus on German Industrial Production results which are projected to contract to 0.3% from last months 1.2% reading. However, given the upside surprise from Factory Orders, the report could print better than expected. The only other release of note will German CPI data which is likely to confirm the deflationary impact of lower oil prices by decreasing -0.4% on a month over month basis.

Political Noise Clouds Yen Strength
The all important Tankan business survey confirmed the fact that Japanese economic performance continues to strengthen printing at 24 versus 21 expected but the good news was partially offset by a slightly lower Capex numbers which rose 11.5% versus 11.8% projected. The net result was that the yen longs were never able to generate enough momentum to break away from the 118.00 level. Later in the week news that North Korea planned a nuclear test over this week-end spooked speculative accounts who quickly moved to the sidelines to wait out the fallout. Over the week-end news services reported that South Korea fired warning shots on Saturday after North Korean soldiers briefly crossed into its side of their heavily defended border, adding to mounting tension. The skirmish follows demands by the UN Security Council the previous day for the reclusive North not to carry out the test and warning of unspecified consequences if it did.

However,  as we noted on Friday, "We continue to believe that once the latest dramatics from North Korea are over, the markets will refocus on relative valuations. To that end,  we do not believe that European officials will be nearly as nonchalant  about yenâ�,��"�s decline against the euro as their Japanese counterparts.  If the EUR/JPY once again lodges above the 150 level, the Europeans are likely to escalate their rhetoric significantly. With global currency exchange imbalances now wildly favoring Japanese businesses the other G-3 players will not tolerate the situation for long and therefore USD/JPY risk lies to the topside rather than the downside." 

Next week, the key release in our book will be the Eco Watchers survey. Over the past two years this measure of man-in-the-street sentiment has been a good forecaster of turns in USD/JPY. If as projected, the gauge once again prints above the boom/bust level of 50 yen strength may not be far behind. If however it disappoints further pain may be in store for yen longs.

Cable Down, But Not Out
Compared to the losses accumulated by the other majors, the British pound fared much better and wrapped up Friday just below the prior weekâ�,��"�s close at 1.8705. Although analysts expected the Bank of England to hold rates at 4.75%, the markets had clearly priced in some risk of another surprise hike as GBP/USD precipitously declined upon the central bankâ�,��"�s announcement. It is highly probable that there was major debate between hawks and doves, especially amidst mixed inflationary data, namely, the downwardly revised estimates of CPI by the ONS from 3.4% to 2.2%. Unfortunately, the minutes of the meeting will not be available until October 18th, so traders will have to wait to try to gauge which direction the BOE will go in November. In economic news, most of the data throughout the week hit the tape with better than expected results, with the manufacturing and services sector continuing to perform well, consumers remaining confident, and house prices still showing signs of acceleration.

This weekâ�,��"�s lineup of UK economic indicators are heavily weighted to the beginning, so Cable movements later in the week may be more influenced by US data and Fed speak. However, markets will be looking towards PPI input and output, house prices, the trade balance, and retail sales on Monday and Tuesday, with the central focus on PPI. If inflation remains muted pound bears may have the upper hand as speculation for further rate hikes will diminish.

Swissie - 50 Basis Points Not in the Cards
The Swiss franc suffered the most extensive losses against the greenback this week as disappointing economic data and the ever-present 350 basis point carry trade differential took its toll. Manufacturing PMI dropped to 64.4 in September, down from August's all time high of 68.2,  and marking the softest balance recorded since May. CPI was similarly disappointing, contracting 0.2% and dragging the annual rate down to 0.8%. The Swiss National Bank's Philip Hildebrand stated this past week, â�,��"inflationary pressures seem much lower in the current recovery than in similar situations in previous years,â�,� and, â�,��"The uncertainty about the potential growth rate and the level of neutral interest rate is rising from a monetary policy point of view.â�,� Mr. Hildebrandâ�,��"�s comments put the markets on edge and effectively negated the possibility of a 50 basis point hike in December. However, economic growth has broadly been in line with the central bankâ�,��"�s expectations, so their intent to further normalize monetary policy remains in tact with a 25 basis point hike considered likely in December.

In the week going forward, the economic calendar is essentially a clean slate. However, the release of the Quarterly Bulletin and Monetary Policy Report by the SNB should provide some insight into the central bankâ�,��"�s outlook and views of the current state of the Swiss economy. USD/CHF longs will likely be looking to the US for news, though, as dollar strength could persevere throughout the week depending on the outcome of the US FOMC minutes from the September 20th meeting.

Boris Schlossberg is a Senior Currency Strategist at FXCM.