Dollar Bounces – But Will It Last?
As usual, the direction of the dollar was determined by Friday’s NFP figure which proved once again that in the FX market its is not the reality but the expectation that matters. As the week progressed, trader’s expectations towards the NFPs turned for the worse, fueled by the sub-prime market which continued to implode and Thursday’s ADP report that forecast a gain of only 57K versus initial estimate of 100K. With the bar now lowered significantly, the actual 97K print on Friday was seen as a relief buttressing the dollar’s bulls argument that despite the woes in housing the US economy continued to expand. The news caused bond yields to rise and gave lift to the dollar. But a look underneath February’s headline number suggests serious structural problems in the report. More than 350,000 workers have dropped out of the job force rendering the low unemployment rate almost meaningless as labor participation rates have declined. Nearly 40% of the jobs this month came from the government sector – hardly a sign of a booming economy. Finally, as many analysts have pointed out BLS birth/death model which arbitrarily adds or subtracts jobs from the final number may have skewed the results the upside in February.

Granted these are the standard gripes of the dollar bears, heard in the FX market nearly every NFP Friday. Nevertheless, the NFP results remain ambiguous. However, next week’s data may resolve some of the key points of the debate. In the US the consumer is king, responsible for more than 70% of all economic transactions. Thus the market’s focus will be centered squarely on Tuesday’s US Retail Sales report projected to rise by 0.3%. If the recent miss by Walmart is a foreshadow of the weakness in overall sales this number could surprise to the downside. If the report meets or beats the forecast, the dollar longs argument will be strengthened considerably as the notion of any Fed easing in the near future will disappear completely from the traders minds. To make matters even more complicated the rise in gasoline prices could actually push the headline number higher but mask the weakness of overall consumer demand. That’s why the market may key off the Retail Sales ex-gasoline as the real indicator of the health of the US economy. Lastly, Thursday will bring the TICS number which printed a woeful $15 Billion last month. If this month’s data rebounds, the market will shrug off December’s reading as an outlier, but if TICS misses badly once again, all bets are off as worries about the structural integrity of the US economy may sweep the market.

Euro- ECB Remains Cagey
Jean-Claude Trichet did his usual dance with the media on Thursday, as the ECB raised rates by 25bp to 3.75% narrowing the interest rate differential with the dollar to 150bp. With the rate hike long priced in, the market, however, was far more interested in the central bank’s next move and as always Mr. Trichet remained deliberately vague refusing to offer any concrete timeline. The economic news in the EZ industrial sector continued to be positive with German Factory orders rising 7.8% on a year over year basis. As we wrote on Wednesday, “The performance of European industry remains key to handicapping future ECB monetary policy moves. As long as that sector expands, generating new jobs, the ECB is likely to maintain its hawkish bias. However, given the fact that consumption in the region remains moribund after the hike in VAT taxes, the whole EZ economy is still very vulnerable to a slowdown and thus a possible reversal in monetary policy, as the composition of growth in the 13 member union continues to be unbalanced.” That is why the general consensus in the currency market is that the ECB will stay pat for at least the next two months as it allows the market to absorb higher rates before tightening monetary policy once again.

In short this means that event risk from the EZ is likely to have only minor impact on trade next week, especially in light of the fact that the calendar is practically barren of any meaningful news. Only the ZEW report stands as a relatively minor market mover, although the Labor costs release may also provide some spark since Mr. Trichet specifically singled out wage increases as the key component of the central bank’s battle with inflation. Overall however, next week shapes up as dollar’s chance to win or lose the race.

Yen – Carry Comes Back with a Vengeance
On Thursday we noted that, “Traders once again plowed into the USD/JPY pair re-establishing carry trades liquidated only a few days ago. Helped by yesterday’s 25bp hike from RBNZ which raised rates on the New Zealand dollar to 7.5%, market appetite for high yielding currencies returned as the lure of still materially wide interest rate spreads was irresistible for some market players… Ironically enough, yen’s weakness comes on a night when Japanese economic data was rather upbeat. Machine Tools orders surged 15.9% from a year ago while the Eco Watchers survey reading rose to within a whisker of the 50 boom/bust line suggesting that the Japanese economic growth may be finally filtering down to the consumer level. The increase in Japanese consumer confidence should lead to an improvement in consumer spending which in turn may provide impetus fro further rate hikes from the BoJ. But for now those thoughts were far from investors minds as yield once again became the sole focus of the day. “

This week, the yield theme may dominate trade once again, especially if US data shows strengths and US bond yields continue to firm. On the Japanese side only two reports worthy of note. On Monday the GDP number could be the most important release of the week if it once again surprises to the upside while Friday’s Tertiary Industry Index – a measure of service activity – could bounce for the first time in several months. In the face of ever improving data, USDJPY will have a progressively hard time rising on yield differentials alone. The price action of the past two weeks has done substantial damage to the carry trade case, and this latest rise in the pair may be nothing but a dead cat bounce. However, if US data proves positive while Japan surprises to the downside, a move to test the recent highs at the 122.00 level is certainly not out of the question.

Sterling-Yen Retrace Unable to Lift GBP/USD
Economic data took a backseat to continued market skittishness, as relatively strong UK numbers were not enough to save the Pound from a second week of declines. An almost unbelievable 2000-basis point tumble in the Sterling-Yen set the stage for continued Cable weakness, while a subsequent 700bp rally was not enough to allow a stronger GBP bounce against the US Dollar. Technical formations show that the GBPUSD will likely have difficulties surpassing weekly highs; continued selling near a 38.2 percent Fibonacci retracement of the recent tumble has left the pair firmly below nearest resistance just above the 1.9350 handle. A muted outlook for upcoming inflation data will likewise do little to help improve Pound sentiment. Instead, the future of Sterling strength will largely depend on further developments in risk aversion across financial markets.

International investors have been all-too-willing to sell the Pound on any hints of market risk-aversion, compounding the dangers around short-term GBPUSD trades. Foreseeable Sterling event risk will be limited to Producer Price Index figures on Monday and wage inflation data due midweek. Economists predict that February PPI figures showed a sharp 0.8 percent rebound in Producer Input costs, but this otherwise GBP-bullish figure will amount to little if PPI Output costs do not follow suit. Bank of England MPC members have shown greater interest in producers’ ability to pass higher factory gate costs onto the consumer. This dynamic implies that forecasts of a 0.2 percent gain in Output prices will not help the case for higher BoE interest rates through the coming months. Instead, GBP bulls hope that Wednesday’s Average Earnings Survey will show especially high wage inflation in the UK economy. Median forecasts of a 3.7 percent year-over-year change would fall far short of the central bank’s tolerated 4.5 percent growth—leaving risks to the downside for GBP-denominated pairs. The lack of upward surprises will shift market focus to the later month’s BoE Meeting minutes and shorter-term developments in world financial markets.

Swissie Gears Up for the Critical SNB Rate Decision
An abrupt shift in risk-aversion sent the Swiss Franc considerably lower against its US counterpart, with impressive top-tier economic reports doing little to help the franc. Both Swiss Unemployment and Gross Domestic Product figures improved outlook for the domestic economy, but this did not amount to further Swissie gains as tame Consumer Price Index figures hurt sentiment going into the coming week’s Swiss National Bank interest rate decision. As we claimed in last week’s report, markets were likely to ignore continued strength in domestic employment if CPI growth did not follow suit. Printing at an anemic 0.0 percent year-over-year rate, recent price data is hardly supportive of higher interest rates through the medium term. This arguably leaves risks to the downside for Thursday’s SNB decision. Indeed, some experts have even questioned the probability of a further 25bp interest rate hike through the coming announcement.

Lack of action by the Swiss National Bank would almost undoubtedly leave the Swiss Franc lower in its wake given the near universal expectations of a rate increase by the market. Yet even a 25bp hike would hardly guarantee Swissie strength; markets hope that any rate move will be accompanied by a continued hawkish bias and expectations of even-higher rates through upcoming meetings. Nearly non-existent inflation suggests that such a hawkish stance is less than probable, however, leading to a more neutral outlook on Swissie short term rates. This may be exactly enough to continue Swissie declines, with a USDCHF-bullish technical outlook only compounding CHF woes.

Loonie Rises Off of Labor News
The Loonie was one of the few currencies to rally against the Greenback through recent trade, underlining the currently bearish bias on the USDCAD currency pair. Friday’s Canadian labor data was the clear catalyst for the currency pair’s drop; a second month of an impressive employment gains (14k vs. 7.5k) overshadowed a similarly bullish US Non-Farm Payrolls report. The USDCAD reversed off of significant resistance near 1.1825 to reach fresh 2-week lows on the news. According to our technical analyst Jamie Saettele, this price action suggests that the pair may test support below 1.1564 in the coming weeks of trade. A relatively empty economic calendar leaves little event risk for CAD-denominated pairs, but any surprises in US data could lead to further strength in the Loonie.

Canadian economic data will be limited to several second-tier reports, but expectations of poor results could out some mild downside pressure on the Canadian currency. Forecasts of a slowing Capacity Utilization Rate may bode poorly for domestic interest rate expectations, as Wednesday’s figures will likely show some softening in the broader economy. Otherwise, markets look forward to Thursday’s Manufacturing Shipment figures. The highly trade-dependant Canadian economy hopes that manufacturing exports continued to grow through January. Forecasts of a 0.7 percent decline bode poorly for domestic industry—putting a damper on a recently bullish wave of Canadian economic news.

Aussie Feeds off of Equity Market Gains
Strong Aussie data was not enough to erase earlier week declines, with powerful Trade Balance and GDP figures leaving the AUDUSD just short of significant price resistance. Its inability to break above a 38.2 percent Fibonacci retracement of its recent tumbles suggests that risks continue to the downside in the short-term, while a relatively empty economic calendar does little to improve outlook for the Asia-Pacific currency. (Technical outlook available here ) Of course, perceived technical resistance may amount to little if markets continue to re-enter high-yielding carry trade pairs, with the AUDUSD clearly supported by a sharp rebound in the popular AUDJPY cross.
Choppy price action is likely to continue through the coming week, as investors’ nerves remain shaken on recently pronounced market volatility. As such, the future of Aussie gains may depend more on the general state of risky investments than of underlying Australian economic fundamentals. This is especially evident in the AUDJPY’s strongly positive correlation with the Japanese Nikkei 225 stock index, as Asia’s investors re-enter previously profitable Aussie longs on renewed confidence for broader financial markets.

Next week, business and confidence numbers along with domestic labor data could be the key triggers for further AUD price moves. Due on Tuesday, private banks will report on proprietary business and consumer confidence figures. Recently positive momentum suggests that we should expect gains in both measures, but either figure will almost definitely be overshadowed by the following day’s employment figures. Economists predict that the Australian labor forces added 15k jobs through the month of February, as economy continued to expand. Though current employment figures are unlikely to have an impact on interest rates through the foreseeable future, a stronger-than-expected result would only improve confidence in the economy and improve the attractiveness of Aussie longs.

Kiwi More Attractive With Another 25bp?
In only a few short weeks, the carry trade was gone from the most lucrative strategy in the currency market to the most profitable fade and back again. And through all of the back and forth, the New Zealand dollar has always been at the front of the crowd. Whether it was the dollar-based major or the NZDJPY cross, a broad move away from complacent risk swept through the market with a selling wave reserved for the high-yielding kiwi dollar hitting the currency particularly hard. However, after seemingly rounding out a bottom on Tuesday, traders are left to wonder if global fears have subsided and the allure of easy money is back in vogue. While interest in low yielding currencies like the Japanese yen and Swiss franc may have simply petered out – the RBNZ no doubt had a part in bringing capital back to the kiwi’s doorstep.

Last week, as was heavily expected by economists and the market, New Zealand’s monetary policy authority decided to raise the nation’s overnight lending rate to a record 7.50 percent. What’s more, Governor Alan Bollard kept the door wide open for further rate hikes – alluding back to the unquenchable growth in housing and consumer spending that he has sited in previous speeches. Though it is not clear how such high rates will effect business growth and the broader economy, the high yield is certainly a draw for currency traders. As of today’s rate, a long NZDJPY position would make an easy 7 percent on unleveraged basis. This may be too tempting for institutional and position traders to pass up. On the other hand, if the excessively high rate starts to further wear on growth, growing instability may arise as a valid reason to stay away from the New Zealand dollars altogether.

Next week, the battle between economic health and returns will heat up with a few key economic indicators that will measure both the business and consumer sectors. From the business sector, the fourth quarter measure of manufacturing activity will survey one of nation’s worst performing sectors. Offering a more up to date read, the ANZ Business PMI for February could take some of the sting out of a particularly disappointing print from the quarterly data. The true crux of the week will be January retail sales, that will either vindicate or invalidate Bollard’s hawkish view on consumer spending.

Boris Schlossberg is a Senior Currency Strategist at FXCM.