Dollar Ready to Finally Turn?
The dollar wobbled and bounced around the 1.3200 level last week as traders fled leveraged positions following the sudden crunch in global equity markets. Economic data out of the US didn’t provide much support for the greenback either, as Q4 GDP was revised significantly lower to 2.2% from 3.5%. Meanwhile, other indicators sent conflicting signals regarding various aspects of the economy. In the manufacturing sector, Chicago PMI had been expected to edge up to the 50 level but hit the tape at a disappointing 47.9 – signaling contraction in the sector. This gloomy report was offset by a solid ISM manufacturing reading, as the figure rebounded to 52.3 and instantly neutralized the poor Chicago PMI figure. On the other hand, a 7.8% contraction in durable goods orders was weighed down by excess inventories. Consumer confidence reports indicated that demand should have been somewhat stronger, as the reading hit a five year high of 110.3 on labor market expansion and accelerated wage growth. In the housing sector, a 3.0% surge in existing home sales helped offset some of the 16.6% plunge in new home sales. However, with new home sales a better leading indicator and sub-prime lenders imploding faster and faster, the sentiment regarding the sector has become increasingly negative.

The dollar looks primed to breakout on the charts, and the economic calendar next week could perpetuate the scenario even sooner as ISM services is on tap on Monday. The reading is expected to ease back to 57.5 from 59.0, but traders will be focusing on the breakdown of the report for the employment component ahead of Friday’s Non-Farm Payrolls, which are estimated to fall back as well. Adding to the tumultuous mix is the Fed’s release of the Beige Book – the central bank’s analysis of economic activity around the country. Should traders see a marked slowdown in the labor market and services sector, dollar bears could propel EURUSD solidly through the 1.3250 level. However, surprisingly strong readings and an optimistic outlook by the Fed could lead the pair to make a definitive turn lower sub-1.3100.

ECB Rhetoric to Make or Break Euro
Traders were unfazed by economic data out of the Euro-zone last week, as EURUSD seesawed around the 1.3200 level on softer CPI and stronger money supply growth. Headline CPI fell back to an annual rate of 1.8% in February - well below the European Central Bank’s 2% ceiling - as continued weakness in crude oil costs have limited a build up of price pressures. Meanwhile, core CPI also missed expectations but did rise to 1.7% from 1.5% as second round inflation effects may slowly be seeping in. In other economic news, M3 money supply for the Euro-zone unexpectedly edged up to 9.8% in January – just under a sixteen year high – from 9.7%. Estimates had been for a dip in the annual rate to 9.5% and the acceleration will underpin arguments for a rate hike by the European Central Bank, as money supply growth has been a major inflation concern.

The slow rise of core CPI along with the hotter-than-expected M3 report are just the impetus needed by the ECB to raise rates this week to 3.75%. However, tightening this time around could be the last until the second half of the year, as overall price growth has remained fairly tepid and the central bank will likely favor a wait-and-see approach in order to gauge the effect of higher rates on consumers, businesses, and the economy as a whole. Additionally, German Chancellor Angela Merkel’s VAT hike to 19% has clearly made an impact on retail sales and sentiment within the country, and the ECB may be wary of exacerbating the problems of the Euro-zone’s largest economy. Euro traders have already priced an increase in interest rates this month, so price action for EURUSD will depend on commentary by ECB President Jean-Claude Trichet. If Mr. Trichet eliminates the term “strong vigilance” from his rhetoric and paints a more neutral outlook for the Euro-zone, implying that the ECB will leave rates on hold, EURUSD could make a definitive turn below 1.3100 this week.

Will the Yen Rally Continue?
The Japanese Yen rallied more than 3.6% against the US dollar last week as traders fled from highly leveraged positions following the sudden tumble of China’s Shanghai Composite index on Tuesday. Meanwhile, economic data out of the Land of the Rising Sun didn’t necessarily warrant a rally for the national currency, as Tokyo CPI contracted 0.2% during February, leaving both annual headline and core CPI flat at 0.0% despite claims from Japanese Economics Minister Hiroko Ota that “the end of deflation remains in sight.” Meanwhile, labor cash earnings slumped 1.4% in January – the sharpest decline in two and half years – even though unemployment has fallen to an eight year low of 4.0%. On the flip side, overall household spending accelerated for the first time since December 2005 at a rate of 0.6%, though the statistics bureau said that unusually warm temperatures this year may have made the gain a one-off event. Nevertheless, with price growth remaining dangerously close to deflation and wages failing to add to any inflation pressures, it is highly unlikely the Bank of Japan will be able even consider further rate normalization until much later in the year.

Despite the fact that Japanese rates remain extremely low compared to other countries and will likely remain so for years to come, carry trade liquidation may remain the theme for the week. The markets are still feeling very skittish about the recent price action in equity markets, and with Japan’s fiscal year coming to a close at the end of the month, repatriation of funds should weigh USDJPY lower. Furthermore, expected improvements in Q4 capital spending, leading economic indicators, and machine orders could be the final nail in the coffin to ensure Yen bullishness during the week, potentially taking the USDJPY pair down to test the early December lows near 114.50.

Cable Knocked Out by Cross Flows
Cable refused to budge for most of the week as the pair struggled to hold near 1.9650, buoyed by solid UK fundamental data as the housing sector and manufacturing sector performed well. However, the biggest move for GBPUSD came at the end of the week as the pair fell prey to carry trade unwinding when the GBPJPY cross plummeted nearly 2% on Friday. Nationwide house prices jumped 0.7% during February to bring the annual rate up to 10.2% while the Bank of England’s measure of mortgage approvals rose to 120K against expectations of a decline to 115K. The figures come as other reports out of the sector have been broadly mixed, as the Bank of England’s aggressive monetary policy actions over the past eight months should start to cool the market. Meanwhile, manufacturing PMI unexpectedly jumped to 55.4 with output, new orders, and export orders all surging, indicating that demand for UK products is slowly building. The employment component rose as well - in line with improvements in the labor market over the past few months – while output prices rose to its highest level since the series began in November 1999, highlighting the upside risks to inflation as manufacturers raise prices amidst a tightening of spare capacity.

Cable could continue to see red this week as economic data such as PMI services, BRC retail sales, and Nationwide consumer confidence are all anticipated to fall lower for the month. The marquee event lies in the hands of the Bank of England, however, which will be holding a monetary policy meeting. Given the relatively tame comments on inflation from the members of the monetary policy committee along with the sharp moves in the global stock markets, the central bank is not likely to lift interest rates from the current 5.25%. Should the BOE decide not to act on policy, there will be no statement available and thus leaves little to trade on. As a result, Cable bears could attempt to push the vulnerable pair towards the psychologically important 1.9000 level.

Swissie Gains in Yen-Linked Carry Trade Liquidation
The Swiss Franc’s month-long rally showed few signs of slowing, as an early week USDCHF plummet left it considerably stronger against major currencies. Indeed, the Franc’s gains were far from limited to US dollar weakness, with the typically slow-moving EURCHF plummeting to fresh two-month lows. The Swissie advanced on pronounced global carry trade liquidation, but unexpectedly strong economic data further fueled its week-long assault. Such economic data-linked strength may continue through coming days with key events on the ledger.

This week promises no shortage of event risk, with the incredibly important Gross Domestic Product, Unemployment, and Consumer Price Index figures due within a three day span. Starting Tuesday morning, analysts expect that fourth quarter Swiss GDP figures will show strengthening expansion rates for the relatively small European economy. Momentum is clearly in the economy’s favor, as there are relatively few weak points that pose risks to above-trend expansion. Exactly 24 hours later, the Swiss Federal Statistics Office is expected to show that Unemployment fell in the month of February. Needless to say, such a result will only improve optimism for Swiss economic health, but it may amount to little to currency markets if the following day’s inflation data does not show a substantive rebound.

The Swiss economy has been enjoying a strong labor market and subsequently robust consumer spending, but official figures show that this trend has been largely non-inflationary. This dynamic is clearly a net-positive for the country, but it softens the outlook for official interest rates and hurts the attractiveness of the domestic currency. Swissie bulls subsequently hope that Thursday’s Consumer Price Index figures show signs of year-over-year inflation, but median forecasts of a 0.2 percent print bode poorly for the currency. The impact of any surprises should be immediately visible, with the Swiss National Bank interest rate decision due just a week later.

Loonie Loses on Sparse Economic Data; Key Events in Coming Week
The Canadian Dollar dropped for the first week in three, as a relatively empty economic calendar left it to the will of its US namesake. Indeed, the earlier USDCAD advance was largely a function of technical levels and relatively unchanged fundamentals—bouncing for the fourth time off of a rising 6-month trendline. Late-week Gross Domestic Product figures only exacerbated the anti-Loonie move, ending a markedly bullish run in domestic economic data. Friday’s GDP figures surprised to the downside, as the closely-watched quarterly numbers showed the slowest year-over-year Canadian growth since 2003. This obscured the fact that month-over-month figures actually showed a stronger-than-expected 0.4 percent gain, but the clear rally in the USDCAD showed that traders largely dismissed such news.

Moderately higher oil prices did little to calm the unfavorable price action, but a continued uptrend in the prized commodity could increase the likelihood of a USDCAD retracement in the coming weeks. Much more importantly, however, North American currency traders will look to the coming week of economic data for the future direction of the Canadian Dollar-US Dollar exchange rate.

A number of first and second tier events promise a heightened level of event risk for CAD-denominated currency pairs through upcoming trade. To start us off, Monday will bring the potentially significant Ivey PMI Survey results, while Tuesday holds Building Permits and a particularly important Bank of Canada interest rate decision. The recently strong wave of Canadian data has allowed domestic bond yields to recover on expectations of stable rates through the medium term—sparking CAD strength. Any hints of dovishness in official statements could easily reverse Loonie gains, however, leaving upside risk for the USDCAD pair. Thursday and Friday likewise bring no shortage of downside risks, with Housing Starts and Unemployment seemingly primed to retrace a previous month of astounding gains. Coupled with a Trade Balance report, it will be of utmost importance to watch late-week news to determine the future of the USDCAD pair.

Aussie Punished by Flight to Safety
Relatively strong economic data was not enough to save the Australian Dollar from sharp declines, as global investors liquidated risky carry trades in a pronounced flight to safer assets. Despite reaching fresh two-month highs through early week trading, the Aussie erased last week’s gains and halved its 0.7700-0.7950 rally through Friday’s action. Not even a stronger-than-expected Retail Sales result was enough to lift the AUD from its lows, as clear selling momentum overwhelmed the high-yielding currency. A bullish wave of economic data notwithstanding, risks seem to continue to the downside for the minor Asia-Pacific currency.

The coming week promises continued event risk for the Aussie dollar, with key Trade Balance, Reserve Bank of Australia, and Gross Domestic Product results due in the span of two days. Traders will hint the ground running, as Monday night’s trade figures will likely elicit moderate reactions from currency speculators. Expectations of an improved deficit could benefit the A$, but traders will likely be reluctant to produce a larger-scale rally ahead of the second day of data. Tuesday night’s Reserve Bank of Australia rate decision will admittedly be a non-event, as there is virtually no chance for a rate move. Likewise significant, the RBA does not immediately release policy statements when there is no change in rates. Just twenty minutes later, however, as the Australian Bureau of Statistics will announce the results for fourth quarter Gross Domestic Product growth.

As one of the single most important economic releases for any economy, markets will pay particularly close attention to any surprises in Australian GDP figures. Analysts predict that continued drought conditions will drag overall economic performance lower, with median estimates calling for a 2.0 percent year-over-year rate of expansion. Risks arguably remain to the downside, however, as a particularly large fourth quarter trade deficit will subtract substantially from the headline figure. Likewise significant, some economists cite that market forecasts underestimate the negative effects of farming declines. Any negative surprises could easily send the Australian Dollar lower, as softer economic growth could single-handedly force the RBA to leave rates unchanged through the medium and longer term.

7.25% Interest Rates Lose Their Luster
The Kiwi lost its status as the darling of the foreign currency markets, as a swift and dramatic carry trade unwind sparked the largest weekly losses in over a month. This drop was especially pronounced in the New Zealand Dollar-Japanese Yen currency pair—a pair famous for its previous 6.75% interest rate spread—with the Yen reasserting its dominance in times of risk aversion. New Zealand economic data did little to assuage fears, with worse-than-expected Trade Balance, Business Confidence, and Money Supply results only exacerbating NZD-bearishness. Needless to say, recent momentum does not bode well for the Asia Pacific currency, but Kiwi bulls hope that an upcoming interest rate hike will return bids to NZD-denominated currency pairs.

All eyes will turn to the coming week’s Reserve Bank of New Zealand Official Cash Rate decision, with the future of Kiwi carry trades riding on expectations of a 25 basis point rate hike. As the economy with the top interest rate of any country with the highest S&P Sovereign rating, New Zealand already enjoys strong foreign investment rates in domestic debt markets. These interest rates are the main driving force behind a ballooning current account deficit, but the effects are clearly a net-positive on the NZ Dollar as traders continue to pile into high-yielding currencies. As such, the Kiwi almost definitely stands to gain if the RBNZ goes forward with a further rate increase.

Economists overwhelmingly expect the central bank to raise rates, with 14 of 15 polled by Bloomberg News predicting a 7.50% Official Cash Rate through the coming announcement. This arguably leaves risk to the downside for the New Zealand Dollar, but the currency’s recent depreciation may actually increase the likelihood of such a rate move. Indeed, one of the primary risks to the current outlook for cash rates is a continued appreciation in the NZD exchange rate. Depending on how officials react to the Kiwi’s recent tumble, we could see New Zealand’s interest rates move higher yet again to 7.50%--leaving the Kiwi higher in their wake.

Boris Schlossberg is a Senior Currency Strategist at FXCM.