US Dollar
In an unexpected twist, what should have been a relatively quiet Friday turned out to be an extremely volatile one. As we expected, the Chicago PMI only triggered a limited reaction in the currency market. Despite a strong 14 point rise in the Chicago PMI index, traders questioned the reliability of the jump because it comes in sharp contrast to the weakness that we have seen in the Philadelphia Fed and Empire State manufacturing surveys earlier this month. Although the Chicago PMI report has had a stronger correlation than the Philly Fed with the national ISM index since 2005, over the longer term, the Philly Fed tends to be the more reliable leading indicator for the ISM. Furthermore, the Chicago number has been faulted for sharp spikes and false signals in the past, which suggests that predicting next week’s ISM number is anyone’s game. Most of the strength came from a sharp rise in new orders and production and since both the employment and prices paid components of the report fell, there is still underlying weakness. Other reports released today were mixed with the PCE deflator and construction spending increasing while consumer confidence deteriorated. Personal spending accelerated from the prior month while personal income growth slowed, indicating that consumers continued to spend more than they earned, which is not a healthy habit. However despite the abundance of US data released today, it was not the US economic reports that drove the significant volatility in the currency and stock markets. Instead, the US Commerce Department announced that they will impose tariffs on Chinese exports of glossy paper for the first time in over 20 years. The dollar sold off on the announcement on fears of retaliatory measures by China and the impact brought on by protectionism. Our special report about the US Sanctions on China – Will there be more to Come? explores this topic even further. In the week ahead, manufacturing, non-manufacturing ISM and non-farm payrolls are the most important US economic releases due for release. The employment components of both of the ISM reports will be used as leading indicators for Friday’s payrolls number, so expect some volatility in the markets should there be any surprises on that front. In the meantime, it is important to look for any responses from China because in all likelihood, this could be the first step towards more sanctions.

Euro
Strength in the Euro today was driven purely by the news on China. The most logical retaliatory measure for China to take, if they were to take one would be to announce that they plan on diversifying a part of their big war chest of foreign exchange reserves away from the US dollar. In that case, one of the most immediate beneficiaries would be the Euro, which has long been chipping away at the US dollar’s status as the world’s premier reserve currency. There were no major surprises in Eurozone data last night. German retail sales growth on a monthly basis was right in line with expectations, but the annualized pace of spending fell more than expected. The rest of the data was relatively positive with French GDP and producer prices firming, the Eurozone CPI estimate increasing, the regional unemployment rate dropping and overall confidence improving. In the week ahead, Eurozone PMI indexes are due for release along with regional PPI, retail sales and German industrial production. US data should dictate trading however since both the US ISM and non-farm payroll reports are the foreign exchange market’s biggest market movers. Meanwhile in Switzerland, manufacturing sector PMI, consumer prices and the KoF economic outlook could trigger some activity in the Swiss Franc.

British Pound
Like the Euro, the British pound is stronger against the US dollar. The GfK consumer confidence report was the only piece of UK data on the docket and it came out right in line with expectations, revealing that confidence remained unchanged at -8 during the month of March. The situation with the captured UK soldiers seemed to have improved slightly. Iran aired a second apology by one of the captured soldiers, but according to Bloomberg News, Iran called upon the UK to ``guarantee'' British vessels wouldn't penetrate Iranian waters again, in a message delivered to the UK Embassy in Tehran yesterday that was reprinted today by the official news agency. It didn't repeat the demand by Iran's military yesterday for a British apology in connection with the naval crew seized in the Shatt al-Arab waterway.” The EU has also stepped in to call for an immediate release of the troops. The progression of this geopolitical risk could play a big role in the fluctuations of the GBP in the days or weeks to come. A swift resolution would be positive for the pound while heightened tensions would be negative. In the week ahead, we are expecting UK PMI, the Nationwide consumer confidence report, industrial production and a monetary policy announcement by the Bank of England. Interest rates are not expected to be changed.

Japanese Yen
Even though the Japanese Yen has rallied against the US dollar, it has struggled to gain strength against the other major currencies. A drop in consumer prices puts the economy back in deflationary mode, which will give the Bank of Japan yet another reason to keep interest rates unchanged. We will need to wait to see whether this is simply a one month anomaly or the beginning of a new trend In contrast to yesterday’s reports, overall household spending increased significantly in the month of February. Industrial production also fell less than expected, prompting Prime Minister Abe to say that the economy is on a strong recovery trend. The only piece of important data expected next week is the quarterly Tankan report on business confidence.

Commodity Currencies (CAD, AUD, NZD)
The Australian and Canadian dollars both strengthened today while the New Zealand dollar sold off following a sharp drop in business confidence and a weaker than expected Q4 GDP report. There was no Australian data released but gold prices firmed. Canada’s stronger industrial production report offset its weaker GDP number. In the week ahead, there is no significant New Zealand data. Australia has a monetary policy announcement along with retail sales and the trade balance. The central bank is expected to leave interest rates unchanged. Canada will be reporting IVEY PMI and employment.

Kathy Lien is the Chief Currency Strategist at FXCM.