Dollar Tug Of War
US economic news on was mixed throughout the week and dollar slowly lost ground to the euro only to recapture most of its losses on Friday afternoon. Dollar’s gain however was not due to a strong NFP number (that report like much of the week’s news was mixed as well) but rather from the rumor from MNI news service which reported on good authority that the ECB would pause for a substantial amount of time after hiking rates one more time in March to 3.75%. Needless to say for a market so focused on interest rate differential compression between the euro and the dollar this was a massive shift in psychology and the pair plummeted nearly 100 points in a matter of minutes.

The message from the US front was that the Fed would stay pat on rates for the foreseeable future, neither hiking nor lowering them. GDP produced a surprise to the upside registering a gain of 3.5% vs. 3.0% expected but the positive news was somewhat offset by the drop in ISM manufacturing below the 50 boom/bust level. Conversely, the disappointing NFP read of 111K vs. 150K expected was alleviated by a large revision upward in the month prior. In short, the US economy appears to be growing at a slow steady pace confirming the “not too hot, not too cold “ goldilocks thesis.

While such a confluence of events may be dear to central bankers heart, it unfortunately makes for some very dull markets. Next week volatility may indeed subside further given the fact that the US calendar carries very little event risk with only the ISM Non Manufacturing report holding some interest for the market. As the week comes to a close attention will doubt turn to the G-7 meeting, but even that may turn out to be a non event.

Euro: Rumor of ECB Pause Halts the Rally
As is so often the case in the currency market, the true move in the EURUSD was driven by something utterly unexpected. The news from MNI that ECB may halt rates at 3.75% after March certainly took the starch out many euro bulls, since the rally in the unit was predicated on the notion that rate differentials between the euro and the greenback will continue to narrow. With both the Fed and the ECB at a standstill the currencies may tread water as well, unless geo-political or other factors intervene in the meantime.

The weeks economic news was generally positive with labor data and German retail sales all showing continued improvement. The Retail PMI plunged to 47.9 form 52.1 expected, but the report had little impact on trading as market players shrugged off the results to one off effects of the hike in German VAT. Overall, the data suggests that the economy in the 13 member region continues to expand at a steady pace.

Next week, the calendar carries only second tier data with exception of PMI Services and EZ retail sales. The euro may get more play on the crosses especially against the yen and the pound if the rhetoric from EZ Finance Ministers begins to heat up ahead of the G-7 meet. However with the unit near the 1.30 level, the exchange rate for the time being does not appear to be much of a hindrance to the region’s producers and unless we see some unusual price activity, the commentary is likely to remain muted.

Yen – G-7 Ahead
On Wednesday we stated, “Yen saw some very mild carry trade liquidation as German Finance Minister Steinbrueck stated that a strong euro remains a risk, triggering off speculation that Euro-zone officials are not going to sit idly by at the upcoming G-7 meeting if the EURJPY rate continues to hover near the 158.00 level. In overnight data from Japan the news once again showed weakness in the labor sector as labor cash earnings declined –0.6% versus 0.6% expected gain. The drop was the biggest decline since August 2005 and continues to suggest that Japanese economic growth remains decidedly skewed towards capital rather than labor. Nevertheless, as we noted yesterday, the yen has become almost inured towards bad news as the pair finds tremendous resistance beyond the 122.00 level especially on fears that G-7 officials will not tolerate a much weaker yen regardless of the country’s underlying fundamentals.”

Indeed as we look at the week ahead the G-7 meet looms as the biggest event risk on the horizon. The one report of interest will be the Eco Watchers survey on Thursday night. This man in the street poll of cab drivers, waiters and barbers is the single best gauge of what’s really happening on the streets of Tokyo and beyond. If the Eco Watchers turns up, it can be the signal that Japanese consumer is back in business and in turn spur speculation that BoJ could finally start tightening.

Pound Steadies
The British Pound was able to recoup losses over the course of the week as some of the fears surrounding the impact of a slowing housing sector were removed from traders’ minds after Nationwide prices continued to register near double digit year on year gains. In addition CBI Distributive Trades survey handily beat expectations hitting 22 versus 6 forecast as the UK consumer sector continued to demonstrate strength and vibrancy. As we noted at the beginning of the week, “The pound showed little reaction to the news as the market remains focused on the fact that BoE will not hike rates in February. However, should the UK data proceed at this pace for near term, the speculation of a rate hike in March is likely to gather force and the pair could stage a second attack on the 2.0000 barrier if currency traders begin to price in such expectations.”

Indeed, over the weekend, the well-read "Position" column in the Nikkei Financial argued that the BoE MPC could again surprise the market with a rate hike this week when it meets to discuss interest rate policy. The column notes that BoE Governor King is inclined to surprise the market and with continued growth in real estate prices which are often used as a gauge for wage hikes in the UK the BoE may decided to maintain its hawkish posture. While we doubt that that will be the case, given Mr. King’s speech of two week ago which clearly stated that the last rate hike was pre-emptive in nature, if the BoE does in fact raise rates once again, that will certainly be the event risk of the week.

Swissie Steams Ahead on Surprising KOF Results
After steadily losing against the US dollar since the beginning of December, the downtrodden Swiss franc - which has suffered from carry trade flows much like the Japanese Yen - finally showed some strength on better-than-expected economic data. The KOF index of leading economic indicators, by far one of the most important releases out of Switzerland, printed much stronger than expected at 1.71 with the month prior’s release also revised upward. As of now, the market continues to believe that the Swiss National Bank will lag the European Central Bank in rate hikes this year, much like it did in 2006. However, as we said last week, “We, on the other hand think that the SNB will match the ECB rate hike for rate hike this year, neutralizing any further carry trade advantage for the euro.” This dynamic should benefit the Swissie against the euro, especially after the EURCHF cross made yet another yearly high last Thursday. The potential now exists for a serious retracement in the pair.

Swiss economic data next week isn’t likely to provide many surprises, with CPI estimated to slip 0.3 percent for the month and the labor market conditions expected to remain tight with unemployment at 3.1 percent. On the flip side, the SECO consumer climate report is predicted to show that sentiment has improved, which points to continued buoyancy in domestic demand and should pick up some of the slack of dwindling exports. The biggest variables lie in commentary at the end of the week, with the SNB’s Blattner scheduled to speak on Friday while G-7’s commences its two day meeting. Should Blattner mention that economic growth remains on track to meet the central bank’s outlook, a Q1 rate hike to 2.25 percent will be essentially guaranteed. Meanwhile, discussions regarding the Japanese Yen at the G-7 are likely to lead to some unwinding of carry trades, which Swissie has fallen victim to as well. Overall, event risk during the week is in favor of those short USD/CHF, as currency tends to trade more on rhetoric rather than fundamentals.

Loonie Lags Despite Stronger Data
Higher oil prices couldn’t keep Loonie afloat last week as Canadian dollar bears ruled trade of USD/CAD. Economic data out of the country, on the other hand, was relatively encouraging as the survey of manufacturing conditions increased from -6 to -5 while the orders component moved back into positive territory to 2.0 from -13.0, pointing to expansion in the sector and resilient demand for Canadian products. Additionally, industrial product prices surged 1.4 percent after stagnating during the month prior on the back of higher metals prices, adding upward inflation risks for the Canadian economy. Nevertheless, with GDP still lagging at a disappointing 0.2 percent during the month of November, data fails to warrant a tightening bias for the Bank of Canada.

Loonie may have the opportunity to rebound next week as Ivey PMI is anticipated to edge back into expansionary territory to 52.0 after falling below 50.0 for the first time in a year in December. However, substantial event risk weighs on the downside as building permits – a leading indicator for the housing sector – are estimated to drop 2.5 percent. Wrapping up the week is labor market data, with the employment change expected to fall to 17.0K from 61.6K. This could be particularly damaging for the Canadian dollar as tightening labor market conditions have led to stronger consumption which has subsequently helped fuel expansion.

Aussie Rebounds Slightly
The Australian dollar inched slightly higher in the past week of trade, as a sharp rebound off of key technical levels helped to prop the currency. Poor results in second-tier economic data was not enough to prevent the Aussie from bouncing off of key support, with the AUDUSD remaining above the 50.0% retracement of 0.7415-0.7982 at 0.7700. If the currency pair manages to hold above significant price floor, it stands a chance to remain relatively stable through the medium term. Such an outlook will greatly depend on near-term developments, however, with the coming week representing significant event risk in AUD-denominated currency pairs.

There are a number of top-tier economic data releases for the week ahead, with the highlights likely to be the upcoming Retail Sales and Employment Change figures. The Australian economy has depended on consumer spending-linked growth as the main driver of broader commerce, lending great importance to Retail Sales as well as labor market results. Lofty forecasts of 0.5 percent monthly Retail gains arguably leave risks to the downside for the Australian dollar, while the later Employment figure will have great difficulty building off of December’s impressive gain. The remaining event risk will surround the significant Reserve Bank of Australia cash rate decision due mid-week. An interest rate hike is highly unlikely and the RBA decision may leave markets motionless in its wake. Traders will have to wait for the RBA’s Monetary Policy Statement on February 12th for a clearer outlook on the future of borrowing costs. Aussie bulls nonetheless hope that the AUDUSD will remain bid above 0.7700 through the short term, while any break downward could re-test 4-month lows at 0.7616.

Kiwi From Biggest FX Gainer To Biggest Loser
The New Zealand dollar has gone from being the best performer against the greenback two weeks ago to being the worst by end of last week. A massive sell order from a hedge fund in Tuesday pushed the unit lower by almost 100 points and it crashed through a seven-month old trend line with authority. Despite the bearish price action, the fundamentals offered up for the week were considerably encouraging. Often considered an objective read on inflation, the year over year money supply growth indicator accelerated to 16.5 percent for December. If it weren’t for a better than expected turn in the trade account, the NZDUSD move may have gone unchallenged. The trade deficit slimmed down to NZ$433 million, the smallest shortfall the country has printed in six months.

Next week, employment data will draw the attention of fundamentalists in the market. On Monday mourning in the Pacific, the quarterly reading of the labor cost and wage indicators for the private sector will dictate how much disposable income the average citizen has going into the new year. The official consensus is for a repeat of a 3.8 percent jobless rate seen in the three months through September. While this would otherwise go unnoticed by the markets, when measured against RBNZ’s expectations of a 4.0 percent rate in its December Monetary Policy Statement, it may already be worthy of hike speculation. Elsewhere for the week, though New Zealand isn’t invited, the G-7 meeting should be monitored closely. If pressure is put on Japan as expected for intervention, a broad yen bid could out further pressure in the kiwi as the carry trade is unwound. All of this should be taken in with respect to technicals. After the break of the big trend last week, a 38.2% fib retracement of the 0.5637- 0.7460 bull wave at 0.6765 propped spot up. Should this level fall, it would be one less hindrance to a deeper contraction.

Boris Schlossberg is a Senior Currency Strategist at FXCM.