Dollar Averts Doomsday
Listening to dollar bears last week one would have thought that the collapse of the greenback was inevitable with the fears over the sub-prime blowup rising to a fever pitch. Dollar bearishness reached its apex right after the FOMC meeting. The Fed acknowledged the problems in the housing sector in its communiqué, leading many market players to assume that US monetary officials changed their bias to a neutral stance. However, the Fed did nothing of the sort. In fact, if anything FOMC members stressed the upside risks of inflation and after a second look the market reconsidered its opinion capping the EURUSD pair at 1.3400. As the week progressed US data turned much more dollar friendly, first with smaller than expected jobless claims on Thursday and then with a much stronger Existing Home Sales results on Friday. Existing Home Sales were pivotal to proving the dollar negative case, and once the report showed that housing demand has not collapsed, worries over an imminent US recession receded.

Nevertheless, skepticism about the rebound in US housing maybe well warranted. As some analysts pointed out, February numbers were mostly a function of business conducted in January and December and therefore offered little insight into market sentiment after the sub-prime problems were revealed in the media in February. Next week brings the New Home Sales release which will either confirm or contradict the Existing Home sales report and could reopen the debate on the state of housing once again. The rest of the week provides only minimal data of importance, although the Consumer Confidence numbers and the Durable Goods report will be key to measuring the strength of both consumer and producers. Unless the data once again turns unremittingly dollar bearish the EURUSD should continue to bounce between 1.3100-1.3400 range as traders look for the next big theme.

Euro Data Doesn’t Help
Euro-zone data provided no support for euro longs this week as consumer spending in both France and Italy contracted sharply. French data showed a decline for the first time in 5 months while Italian Retail Sales fell much worse than expected, printing at –0.4% vs. 0.2% forecast. The drop in the Italian readings was the worst in nearly two years. The persistent weakness in EZ consumer demand therefore stood as a strong counterpoint to the robust economic growth amongst the regions’ producers and highlighted the imbalances still present in the system.

That unhealthy dynamic was not lost on ECB policy makers. Slovenian Central Bank Governor Mitja Gaspari addressed the issue indirectly on Friday when he stated that it was premature to talk about more rate increases noting that current interest rates are “appropriate”. The ECB has apparently decided to allow the EZ economy to digests the most recent series of rate hikes before imposing any additional tightening on the market. Therefore, with consensus now coalescing around May as the earliest possible date for the next ECB rate hike, the euro came under more profit taking pressure as traders saw no immediate catalysts for further gains to the unit.

Next week the IFO report kicks off the calendar for the EZ and caution may be in order given the fact that the Belgian Business confidence survey dropped from 3.6 to 1.5. Since Belgium does 95% of its trade within EU the survey is often used by traders as a proxy for the much more important IFO reading. Although there has been deviation between the two surveys over the past few months, the sharp drop in the Belgian Business confidence may suggest that the high exchange rate of the euro may be starting to negatively impact producers in the region. As the week wears on the EZ data should improve with Consumer confidence and unemployment continuing to show gains. However, whether this positive news will be enough to push the unit back to the 2007 highs remains to seen.

Yen – Back to Carry as BOJ Stays Pat
As expected the Bank of Japan held rates steady voting unanimously to maintain the repo rate at 50bp. Japanese monetary officials stated that the economy continues to expand moderately but also noted that consumer inflation remains low - words that many market patricians took to mean that the central bank is unlikely to tighten further before Japanese parliamentary elections in July. Although no one expected a hike this time, most traders were looking for decidedly more hawkish tone from Mr. Fukui and co. and whether they meant to or not, BOJ officials once again flashed a green light to the carry trade speculators who were only too eager to jump right back into the market. As a result the yen once again lost ground against all the majors, most heavily against the high yielders like Aussie Kiwi and pound.

For the past two weeks almost all Japanese economic data has been ignored by the currency market as the pair traded strictly on the two opposing themes of carry trade and risk aversion. That dynamic may well continue next week, but the calendar does hold some important data including Retail Trade on Wednesday and Unemployment numbers as well as inflation releases on Thursday. The yen is unlikely to stage a major rally unless global equity market turn downward, however it may get some temporary relief if the economic indicators show improvement.

Sterling Strengthens on Inflationary Reports
Wave after wave of solid UK economic releases underpinned Cable strength for the week, as the pair picked up pace towards the 1.9700 level, brushing off news that Bank of England member David Blanchflower surprisingly voted to cut rates in March. First up, Rightmove House Prices for the month of March surged 1.5 percent, bringing the annual rate up to 12.2 percent, as housing demand continues unabated throughout the UK, especially in ultra-expensive central London. House price growth along with oil prices have kept CPI elevated, as the headline figure increased to a greater-than-expected 2.8 percent in February while RPI rocketed to a 15Ã,½ year high of 4.6 percent. Meanwhile, retail sales posted their sharpest gain in more than two years as the figure rose 1.4 percent during February, recouping much of January’s 1.5 percent plunge. With inflation holding at such lofty levels and consumption still on track, the BoE is likely to maintain its hawkish stance despite the antics of the dovish Mr. Blanchflower, potentially putting rates in the UK on track to trump those of the US and making the sentiment for GBPUSD increasingly bullish.

News flow out of the UK next week will provide little spark for the British pound, as economic indicators for the country are generally anticipated to remain unchanged. House price growth, as measured by Nationwide Building Society, is expected to rise during the month of March while the annual rate of growth is predicted to slip to 9.6 percent from 10.2 percent, leaving the markets wondering if the sector is finally slowing. Mortgage approvals for the month of February will add to the confusion, with the level expected to slip to 118K from 120K. Meanwhile, the final reading of Q4 GDP isn’t likely to provide any surprises, but any revisions to the original report of 0.8 percent growth for the quarter and 3.0 percent expansion for the year could create some wild volatility. Wrapping up next week will be GfK’s release of consumer confidence, which is projected to show sentiment holding steady at -8. With most UK releases second-tier in nature, Cable price action will be vulnerable to US data and could open substantial downside to the pair below 1.9600.

Swissie’s Tide Could Turn on KOF Release
The Swiss franc racked up marginal losses over the course of the week as the USDCHF pair gained to just below 1.2200. However, economic data out of Switzerland was generally supportive of the national currency, as the trade surplus unexpectedly widened to 1.38 billion francs from 1.29 billion francs. A breakdown of the data showed a 3.4 percent drop in imports, while exports slipped 3.2 percent. Nevertheless, the decline in exports signaled that the Swiss economy may have to become increasingly reliant on domestic demand for expansion. Meanwhile, producer and import price climbed a surprisingly hot 0.3 percent in February, leaving the annual rate steady at 2.2 percent. The rise in the monthly figure was led by higher metals costs and raises the potential for a rebound in consumer prices. Furthermore, the price data along with comments by Swiss National Bank member Thomas Jordan saying, “From today's perspective, the normalization of monetary policy is not completed yet," keeps the central bank on track to hike rates 25 basis points at their next quarterly meeting.

Swiss economic data is expected to be mixed over the course of the next week, but much of Swissie’s price action will be contingent on the market’s attitude towards the carry trade and the result of the KOF leading indicator, which is estimated to rise slightly to 1.83. The figure will likely reflect solid consumption growth, as continued investment by Swiss companies in investment and hiring has kept unemployment near record lows. Nevertheless, if risk aversion shifts and traders decide to flock towards higher-yielding currencies, Swissie could be at a distinct disadvantage next week.

Loonie Rallies on Interest Rate Outlook
The Canadian dollar was among the highlights in the past week of trade, with a surprisingly high domestic CPI reading forcing strong appreciation against its US counterpart. Markets largely expected a soft Core price inflation reading to reinforce the Bank of Canada’s neutral monetary policy bias, but the material gain effectively ruled out any possibility of a rate cut in the near term from the BOC. Though it is still too early to claim that upside surprises in inflation and employment will push the central bank towards a tightening bias, markets have clearly scaled back expectations of monetary policy easing through 2007. Emphasis on recent Canadian economic strength will continue into the coming week of trade, with key Gross Domestic Product numbers to highlight event risk for Loonie pairs.

Whether the Canadian dollar will continue to gain may depend on the upcoming GDP report. Analysts expect that the Canadian economy grew at a 0.2 percent pace through the month of January—exactly half of the previous month’s gains. The bearish consensus number is largely due to declining Manufacturing Shipments on the month, while unchanged Retail Sales likewise leave risks to the downside for the headline figure. This could potentially weaken the domestic currency, but Canadian dollar bulls claim that low January GDP numbers will be offset by February and March gains. Suffice to say, strength in the labor market will only go so far if it does not coincide with broader economic expansion.

Aussie Pounces on Dovish FOMC, Reaches 10-Year Highs
The Aussie regained its darling status among across the currency trading world, reaching 10-year highs against its US namesake. A reaction to the US Federal Reserve interest rate announcement was the clear highlight of the week, as high-yielding currencies rallied sharply against the weakened Greenback. Although it was subsequently unable to move higher through the week’s end, but the currency’s break above the psychologically significant 0.8000 mark underlines the bullish bias to AUDUSD trading. A relatively empty calendar gives Aussie bulls little to look forward to in the coming week, leaving AUD pairs to the will of broader market flows.

Markets are likely to ignore largely second-tier economic data, but any material surprises could just as easily force retracements in the high-flying Australian currency. This is particularly true for late-week Job Vacancies figures and a Private Sector Credit survey. The recent focus on overwhelming strength in the domestic labor market and its effects on consumer spending lend particular importance to employment prospects and consumer borrowing. Indeed, speculation of a further Reserve Bank of Australia interest rate hike hinges on continued strength in job growth and spending. Watch for large surprises in either of Thursday or Friday’s reports to guide AUD pairs. Otherwise, the small continent’s currency will largely trade off of developments in nearby New Zealand and the United States.

Kiwi Moves Will Once Again Run On Fundamental Fuel
In the past week, the New Zealand dollar has soared against most of its major pairings. Against the US dollar, the five day Kiwi rally has totaled 139 points, or nearly 2 percent. What was the impetus for such a move? Over the same five days, only two indicators hit the New Zealand wires: visitor arrivals and credit card spending, both for February. Each report printed better than their previous numbers. The boost in short-term visitors is a boon for an economy that is dependant on exports (like tourism); and the acceleration in consumer spending using short-term credit helps recall the RBNZ’s hawkish rhetoric following its decision to hike interest rates in the last monetary policy meeting. However, the implications of both numbers on growth and policy is considerably more short-sighted than the moves in the kiwi would suggest. Instead, the steady rise in NZDUSD seems more the product of reestablished carry trades than anything else. For confirmation, nearly every one of the yen pairs has rallied over the week as premiums for protective options have subsequently dropped.

In the coming week, the prominence of the carry trade will be tested against a fully stocked economic calendar – and this time, the indicators are of the market-moving quality that can actually alter the market’s perspective of the New Zealand currency. The action starts early with a trade report that will measure the support export revenue will add to domestic consumption. At the same time, the balance will provide policy makers with a relatively objective gauge as to how the level of the national currency is affecting foreign demand. Later in the week, the fourth quarter current account balance will tender much of the same sentiment, though it will hold the undesirable label of a lagging indicator. The quarterly consumer confidence report from Westpac, on the other hand, will generate considerably more interest. Encompassing the first three months of the year, the report holds no official consensus though it has advanced in its previous two prints and is still relatively depressed in comparison to the readings from the previous three years. The fundamental crux of the week, oddly enough, comes at the end of the week. On Friday, kiwi traders will absorb NBNZ’s survey of business confidence for February. However, the attention paid to this proprietary number will rely completely on the health of fourth quarter growth that will have been revealed only a few hours earlier. Recently, estimates were running rather high with a 0.9 percent consensus. However the indicator prints, it will be immediately and directly contrasted against the RBNZ’s hawkish monetary policy. If the market is offered tangible evidence that the economy is faltering under the central bank’s taxing strategy, traders will begin to worry that either rates or the economy will have to give way.

Boris Schlossberg is a Senior Currency Strategist at FXCM.