Dollar: Moving Nowhere Fast
The economic news this week was actually rather positive for the greenback.  Industrial Production expanded at 0.4% vs. 0.1% expected while the housing sector showed a nice bounce both in building permits and through the NAHB survey. Even inflation data ran hot with both CPI and PPI  printing multi month highs.  Overall the news flow indicated that chances of a Fed rate cut in Q1 were virtually  non-existent and in fact greenback bulls had a strong argument for a potential rate hike given the elevated price levels and still robust economic growth.  The only cloud on the horizon came in the shape of the TICS data which  posted a surprisingly small surplus of 62 Billion against 74 Billion projected. However, even here the news was not nearly as negative as the headline suggested. The compression in the surplus was driven more by the sharp increase in US demand for foreign securities rather than lack of foreign demand for US stocks and bonds.  Nevertheless the greenback failed to make much progress and the reason may have more to do with the fact that the pair approached the critical 1.2900 level this week attracting bargain hunters

Next week promises to be rather quiet with only second tier data on the docket as LEI and Richmond Fed  kick off the calendar and housing data and durable goods close it out. None of the releases are expected to be especially impressive, although given this week’s strength in housing numbers a small upside surprise may be possible in the Existing homes data.  With little economic news to drive order flow we may trade on exogenous events, but if the geo-political scene is quiet expect another numbingly boring  week of range.

Euro at a Crossroads
The euro kicked off the week with bang as the ZEW survey printed better than expected registering a reading of 70 versus 61 forecast but the unit soon ran out of steam as Industrial  Production showed a marked slowdown from 0.7% anticipated to 0.2% indicating that the primary engine of growth in the region may be finally feeling the effects of higher exchange rates. Certainly Italy, the laggard of the big three produced lackluster results as Industrial Sales rose only 0.2% on a month over month basis. As we noted on Friday, “Whether the fact [that Germany] will be enough to pull overall EZ growth higher remains to be seen. For now doubt remains about the pace and intensity of any further ECB tightening and if EZ data begins to falter, rate expectations may be lowered even further. “
 
Next week the always important IFO should shed light on the true state of affairs in the Euro-zone. If the survey maintains its readings near decade highs, markets’ doubts may be allayed. However, should the IFO post a  downward surprise, it may be an early warning signal  of a possible slowdown in the Eurozone. At the very least it will  spur speculation that ECB may pause for longer than just one month. Therefore, with a very light calendar on both sides of the Atlantic, the IFO stands out as  the most important event risk of the week.

Yen Gets Pummeled
No doubt, the seminal event of last week was the BoJ announcement to hold rates steady for yet another month, causing USD/JPY to rally to two year highs while EURJPY passed 157.00 once again and GBPJPY broached the physiologically important level of 240. As we wrote on Friday, “Many analysts have criticized the BoJ for caving in to political pressure, but the fact of the matter is that Japanese fundamentals provided little support for further tightening at this time as the Japanese consumer clearly went into a funk at the end of Q3. Furthermore, as many commentators have pointed out Japan’s financing costs of its federal debt – the largest in the industrialized world – now account for  more than 25% of all tax revenues and that fact may have weighed on the banks decision to hold off on tightening until monetary officials were certain that Japanese economy could absorb the shock.  With the rate news now behind us the pair is likely to range trade between 120-122 level  until Japanese economic data provides a clearer picture on  whether the bank will finally act in February or will be forced to hold off for yet another month. “
 
Next week will see the release of the BoJ minutes which should offer traders more clues as to contentiousness of the debate on rates within the confines of the policy committee.  Additionally the All Industry index and the Trade balance data are expected to hit the tape but neither release is likely to offer much of an impact on FX trade. The focus now will turn to next month meeting and the handicapping of rate hike expectations.  At present the market has absolutely no reason to buy yen as the unit’s miniscule yield and lackluster growth make it the  black sheep of the G-3 universe. However, with carry trade positions so crowded, any small move could trigger a stampede. Therefore the true movement in the pair next week may be driven by rhetoric rather than economic releases, but until such time that fundamentals show some improvement the yen will continue to be the victim to the carry.

Cable Continues Its Winning Ways
UK data continued to shine with jobless claims, retail sales and inflation gauges all printing better than expected, but after  last week’s surprise BoE rate hike much of the good news was already baked into the  price. In fact the pair made a reversal on Friday despite a very good print in retail sales. As we noted "After rallying for 6 out  of the last 7 days, cable ran in to a slew of offers at the 1.9770 level despite the fact that Retail Sales handily beat estimates printing at 1.1% versus 0.5%.  However, the price correction in cable may well  be short lived as  UK data continues to impress and points to further rate hikes from the BoE going forward. The only danger to the pound bullish scenario would come from  a marked slowdown in UK’s housing market. Next week brings the housing data from the Rightmove survey and traders will pay careful attention to this news given the surprising slip in RICS readings this week."

Aside from  the Rightmove, the CBI Industrial Trends survey and BoE minutes will also impact trade. The pounds rests at a critical technical juncture having rallied and failed several times at the 1.9800 level.  This zone become vitally important if the unit is to make a serious assault on the 2.000 figure any time soon. For now the data has been nothing but pound supportive but the unit  could still stall ahead of this level if currency traders sense any sign of slowdown.

Swissie Declines in Sympathy on Yen Tumble
The Swiss Franc remained largely range-bound through the past week of trade, as relatively light data provided little direction for CHF-denominated currency pairs. Indeed, the economic data that was released did nothing to improve the Swissie’s stance against the dollar, as a bullish Adjusted Retail Sales report actually preceded a USDCHF rally. Instead, the CHF traded off of interest rate-linked demand for higher yielding currencies. Following the contentious Bank of Japan interest rate decision, monetary flows clearly favored the USD, GBP, NZD, and AUD against other currencies—with the Japanese Yen leaving the Swiss Franc lower in its wake. It remains to be seen whether this somewhat odd correlation will persist, but strength in Swiss economic data may keep the CHF afloat in the coming week of trade.

The divergence between the Japanese and Swiss economies should be nowhere more apparent than in upcoming inflation data, with Monday’s Producer and Import Price data to show relatively substantial price pressures for domestic industry. Predicted to print at a robust 2.7 percent, PPI growth should highlight price risks to the economy and prompt further Swiss National Bank monetary policy tightening through the medium term. Falling oil prices mean that risks arguably remain to the downside to consensus estimates, but persistent year-over-year changes in 2.5-3.1 percent range tell us that the overall trend shall remain intact. Otherwise, economic data will be limited to the UBS Consumption Indicator due on the 26th. With November’s Adjusted Retail Sales clearly surging above expectations, risks may remain to the upside for the December UBS figure. A promising outlook on upcoming fundamentals should lend support to the Swiss Franc, but it remains to be seen if investors will return to lower-yielding currency pairs. As such, Swissie demand may likewise depend on upcoming Japanese inflation figures.

The Loonie-Crude Relationship Deepens
There were two fronts for the Canadian dollar last week: macro economics and crude oil. Sticking with the more consistent indicators first, the economic calendar was well stocked with interesting reports for the fundamentalists to trade off of. The data flow started off innocuously enough with November vehicle sales that matched the markets expectations for a 3.0 percent pick up. Not overlooking any relationship, currency traders knew this indicator would offer a generous hand to the forthcoming retail sales report for the same period. However, the wholesale sales statistics wasn’t in the same boat. Expected to rise a healthy 0.6 percent in December, purchases at middle-man level actually ran thin with a 0.1 percent rise. Elsewhere, the once hailed BoC announcement has been regaled to bathroom break time, as the central bank passed up a rate change. The policy group further squashed speculation for the possibility of future hikes by suggesting risks on both sides have faded. The dour look on the economy was brought to neutral hues with a brighter outlook for US growth and relief in the exchange rate, while interest rates (both core and headline) pulled closer to the BoC’s target rate. An interesting after thought of the meeting was the downgrade in the 2007 growth forecast from 2.5 percent to 2.3 percent, but even this failed to ruffle feathers. The real surprise for the week was the 31-month high in net foreign investment as investors snatched up bonds.

For the week ahead, the economics will once again play a small role in the loonie’s future. December’s CPI will turn few heads as it is expected to once again edged in closer to the target level. Retail sales will draw in a few more spectators, but the real action will be with crude. Over the past few weeks, as oil prices have relentlessly worked their way lower, USDCAD has stalled its own ascent below 1.18. Typically the negative correlation between the two is high. Now flirting with a sub-$50 per barrel move, its pressure time. Taking out this very psychological level may finally erase the 1.18 problem. On the other hand, the loonie’s strength in the face of the crude drop may indicate that a turn in oil will catalyze levels of underlying strength held in reserve just for such an occasion.

A One Track Mind -- Aussie Inflation
In a time where interest rates and the carry trade are the topics on every currency trader’s mind, the Aussie dollar’s esteem has ballooned to nearly unsurpassed levels. Among the eight majors, it is surpassed in yield only by New Zealand. However, Australia’s currency comes equipped with an economy that can actually back up its attractive lending rate – and support the necessity for further rate stimulus in the future. Over the past week, a few indicators were hitting the wires. One surprise came from Westpac’s Leading Index indicator for November, though it appeal is tarnished due to its lag, the November read was surprising nonetheless as the release (used to forecast growth) reported its biggest jump in seven years. Already sailing into its 16th year of positive growth, the economic furnace is being stoked by a unquenchable demand for soft and metal commodities from China and a cycle of domestic consumer strength. While this was a noteworthy indicator, the real deal was the two inflation indicators offered up for the week. More sentient, TD Securities’ monthly consumer price index for December encouraged Aussie bullishness when the annual rate accelerated to match a seven-month high. At 3.8 percent, this unofficially tops the RBA’s 2-3 percent band. The other price gauge was given more weight as it was from the government’s own books. The import price index hit rate expectations hard with the biggest quarterly drop since the first three months of 2004.

Now, inflation hawks are divided on which indicator to follow.  Taking the optimistic TD numbers runs the risk of a divergence from the government’s numbers; while following the import price index’s lead may be faulty as firms try to reap profit from strong domestic consumption. The feud will be settled next Wednesday with the government’s fourth quarter read on inflation in the consumer basket. Quarterly expectations are already running light, but the real event risk surrounds the annual figures – which are conspicuously higher in both core and headline projections. A more accurate bearing will be offered in the first few hours of liquid trade with the producer price gauge, but CPI will be ultimate destination. If expectations are met, 3.8 percent inflation could be the impetus for a 6.50 percent rate.

Kiwi Awaits Critical RBNZ Decision
Disappointing economic data was not enough to hold back Kiwi gains, as the high-yielding currency benefited from a wave of carry trade buying interest. Much as we expected in last week’s report, fourth quarter Consumer Prices data was the clear highlight of the week. Given a significant drop in headline consumer price inflation, the New Zealand posted significant declines against major counterparts. The 1.1 percent tumble did not last for long, however, as a subsequent Japanese Yen sell-off and renewed interest in New Zealand’s 7.25 percent interest rates pushed it higher through Thursday trade. In fact, overall bullishness allowed it to recover from a Retail Sales report that saw the first decline in seven months. It remains to be seen whether the Kiwi will continue to benefit from carry trade interest, with the upcoming week to prove critical to the future of domestic interest rates.

The New Zealand dollar will see great event risk in the week ahead, with the key Reserve Bank of New Zealand interest rate announcement due through Wednesday night’s Asia session. Markets had previously priced in a better than 50 percent chance of a 25 basis point hike to 7.50%, but soft inflation and retail sales data have tipped the scales in favor of inaction. Despite the shift, however, there remains a significant minority that has priced in the probability of a rate hike. This leaves markets primed for significant price volatility ahead of the event, as either a hike or no change could provide price swings. Whether or not they raise rates, the bank will release its monetary policy assessment. December’s statement highlighted household spending as the greatest risk to price stability, with falling oil prices likely to slow inflation through the near term. Given a drop in retail sales, however, the bank may soften its rhetoric on outlook for domestic price pressures. If this occurs, the Kiwi could lose ground against major counterparts, with a more dovish central bank threatening future interest rate changes.

Boris Schlossberg is a Senior Currency Strategist at FXCM.