Dollar Tarred By Tariffs But Will NFP Be Its Savior?
It was hardly a banner week for US economic data, as the calendar bled red until Friday. New Home Sales plunged to an 848K annual run rate – well below the 1M necessary to allay fears of a housing recession. Durable Goods also printed lower than forecast bouncing back a paltry 2.5% from the 7...6% contraction the month prior. On the other hand, as the week moved to a close the economy registered a few positive surprises. GDP was revised upward to 2.5% from 2.2% excepted and Chicago PMI skyrocketed to 61.7 from 49...4 forecast. However, the GDP numbers ware backward looking and the market took the Chicago PMI readings with a barrel of salt. Although the headline number was very strong, the internals were decidedly less positive. The employment component actually dropped to 45 from 50.6 and prices paid were lower too, falling to 59.1 from 63.2. New Orders were responsible for the vast majority of the increase jumping to 72 from 48. The news may suggest that the US economy remains far healthier than the bleak scenarios of dollar bears, but a careful look at past Chicago PMI readings shows at least two instances where it flashed a false positive versus the national ISM report.

However, all of the weeks data receded into the background after US announced Friday afternoon that it is imposing tariffs on Chinese products for the first time in 23 years. The actual impact of the tariffs is miniscule, affecting just some paper products, but the market instantly thought “Smoot-Hawley” – the notorious tariff legislation of the 1920’s which many economists believe led to a contraction of world trade and exacerbation of the Great Depression. The dollar was quickly sold briefly touching the 1.3400 level before some profit taking brought it back by the close of trade.

Next week, traders will be able to see rather quickly if the optimistic readings from Chicago will be confirmed by the national data of the ISM Manufacturing. For the time being the national report continues to hover above the 50 boom/bust level, although it did dip twice below 50 in the last 6 months. However, the true driver of currency movements next week is likely to be the US NFP report due next Friday. The market remains optimistic about the US job picture looking for a 120K print versus 97K last month. Indeed, continued job growth has been the principal argument of greenback bulls, who’ve noted that it serves as a powerful antidote to the recent problems of the housing sector. If job growth does keep pace, the bears will have a hard time convincing the market that a US recession is just around the corner but with geo-political tensions swirling about there is no guarantee that even good news will translate into dollar strength.

Euro – The New Reserve?
The news from the Euro-zone was rather predictable this week. ECB members remained hawkish, production data surprised to the upside and consumer sentiment improved. The IFO report beat expectations, as the reading in the Business Climate conditions rose to 107.7 from 106.5 reversing the pattern of two consecutive monthly declines. The news surprised the market given the sharp drop off in the Belgian Business indicator last week, the persistently high exchange rate of the euro and the recent upward creep in oil prices. Yet despite all of these challenges, European business sentiment continued to hold near record highs, confirming the euro bull’s position that the EZ economic growth may be decoupling from the evident slowdown in the US. Later in the week, much better than expected German unemployment numbers only served to support that thesis.

But euro true strength did not appear until Friday afternoon, when it reverted to its familiar role as the anti-dollar after the US tariff against China. As Kathy Lien noted in her commentary on the matter “The impact of tariffs on glossy paper imports is small…but the reaction in both the stock and currency markets today reflects the belief that this announcement could set a precedent towards more sanctions in the future. China may decide to retaliate by diversifying some of their big war chest of foreign exchange reserves away from the US dollar. The biggest beneficiaries would be currencies such as the Japanese Yen, Euro and British pound. “China has already started paying for Iranian crude in euros. If this move leads the Chinese authorities to curtail their stockpiling of FX reserves in dollars the change can have a monumental impact on the euro which would quickly become the dominant reserve currency.

Next week European calendar brings Manufacturing and Services PMI numbers along with EZ Retail Sales and German Factory orders. Almost all of the data is forecast to be positive, and if it is the euro could trade even higher, but given the latest news the direction of the unit is most likely to be driven by markets assessment of geo-political risk .

Yen – Risk Aversion Back in Play
On Friday morning we wrote, “We have been rather astounded at the near universal complacency of financial markets this week given the geo-political tensions in the Persian Gulf. As the conflict between UK and Iran remains unresolved, the price of crude will reflect a steep risk premium. From an economic perspective such a dynamic remains highly damaging to the US economy as it continues to divert discretionary income to the gas pump. It will be interesting to see if the markets finally respond to the current geo-political dangers or whether they will maintain their disinterest betting on a diplomatic resolution to the stand off.” No sooner had we written those words than the news of the US tariff against China along with continued tension between UK and Iran sent stocks lower and yen higher. The currency continues to be pushed and pulled by the opposing themes of risk aversion and carry trade as traders see no possibility of any additional rate hikes from BOJ. However Friday also some positive economic news out of Japan. Overall household spending improved markedly rising 1.3% vs. 0.6% forecast. This was the single best reading in 16 months and the first time that this release showed two consecutive months of positive gains since the summer of 2005. For yen bulls this small piece of good news may the first indication that Japanese consumers are finally ready to increase spending. The Japanese economic recovery has been highly unbalanced, with the vast majority of the recent growth in the GDP benefiting corporations rather than consumers. If Household spending continues to trend positively for the next few months, BOJ will have considerably more leeway in tightening monetary policy and that in turn should prove bullish to the yen.

Next week the calendar is extremely light with only the Tankan as the sole event risk on the docket. The market is looking for a small improvement which could provide mild support for the yen, but if equity markets once again become volatile the currency may see much larger gains.

Critical Bank of England Rate Decision to Drive the Pound
Markets have largely ignored recent economic data, as a relatively empty calendar provided little direction ahead of the coming week’s contentious Bank of England rate decision. The Pound has also remained relatively unharmed by the ongoing standoff between the UK and Iran—suggesting that speculators have underestimated the potential impact of an escalation in geopolitical risks. How the entire situation pans out may be critical to GBP price action, but traders may be slow to adjust positioning in the absence of a clear deterioration in current conditions. In the meantime, the focus will turn to upcoming UK Industrial figures and the key central bank interest rate announcement.

Consensus estimates show that economists expect the Bank of England to leave rates unchanged through Thursday, but a vocal minority continues to price in a 25bp rate hike through the announcement. Doves cite the most recent Monetary Policy Committee vote as clear evidence that the bank is unlikely to move on rates; an 8-1 vote in favor of leaving targets at 5.25 percent arguably shows little willingness to tighten monetary policy through the short term. Those on the opposite side of the aisle claim that recent inflation numbers and lower volatility across world financial markets may embolden hawks and force a 25bp change. The “shadow” MPC, a number of independent economists that meet under the auspices of the Institute of Economic Affairs, voted to take rates to 5.5 percent through their most recent “decision”. Though this obviously has no bearing on the actual central bank announcement, this group accurately predicted the previous surprise hike in January and correctly forecast the preceding two rate moves. Time will tell if the BoE is to move in April, but traders should prepare for either potential scenario and adjust positions accordingly ahead of the result.

Swissie Proves Indifferent to Strong Economic Data
The Swiss Franc largely ignored positive Macroeconomic data, with a late-week reversal leaving it marginally higher against its US counterpart. The domestic KOF Leading Index printed well-above expectations at 1.90, but traders showed little willingness to drive the Swissie higher on the overwhelmingly positive news. It seems as though speculators have grown used to the constant stream of upbeat economic data and will need more to keep the Swissie bid in the medium term. The coming week will arguably provide much of the same price action, as the SVME PMI and Consumer Price Index promise few surprises. Indeed, markets are likely to ignore Tuesday’s price inflation figures, as the Swiss National Bank has made it very clear that it expects low inflation until the second half of the year. Given little perceived event risk, the CHF may instead trade off of developments in rising global geopolitical tensions.

The Swiss Franc has arguably lost its status as the world’s safe haven currency, but recent developments may force global investors to return to neutral country’s currency on escalations in global instability. One only needs to examine the current focus of perceived risks; instability in the Middle East could dramatically improve the attractiveness of the Franc. Unlike in recent times, the US dollar will not provide the flight to safety that the global investor has grown accustomed to. With the United States inextricably linked to ongoing developments involving Iran, traders are highly unlikely to buy dollars on a deterioration of the current UK-Iran standoff. Watch for the Swissie to gain on any fresh developments in the ongoing struggle for the captured UK sailors and/or the Iran nuclear dispute.

Loonie Strength Dependent on Ivey PMI Result
The recent rally in oil prices sent the Canadian dollar higher this week, while a sparse economic calendar did little to boost the currency. Indeed, crude traded near six month highs above $68/bbl on Friday as tensions in Iran continued to mount. One of the 15 British service members being held captive in Iran appeared on state television and apologized “deeply” for entering Iranian waters. The country also released a third letter from the one female in the crew, Faye Turner, saying she has been “sacrificed” by “the intervening policies of the Bush and Blair governments.” Meanwhile, the Canadian economy expanded at a slower pace than expected in January at a rate of 0.1 percent – the slowest pace in four months - versus 0.2 percent predicted. From the various sectors, the primary draw down was from manufacturing, which plunged 1 percent despite improvements in the trade report and the Ivey PMI report. On the other hand, energy production picked back up for the month to offset some of the declines. Overall, the release is a weak follow-up to fourth quarter GDP, which hit a three year low of 1.4 percent and should keep the Bank of Canada on edge regarding the downside risks to growth.

Economic data out of Canada may be broadly mixed this week, as building permits for February – a leading indicator for the housing sector – are estimated to drop 8.5 percent while employment gains are forecasted to slow to 10.0K in March from 14.2K during the month prior. However, Canadian dollar price action will likely be contingent upon the release of Ivey PMI. The manufacturing indicator is anticipated to jump to 62.0 from 60.5, suggesting that the sector’s softness registered in January GDP may have been a one-off event. The situation in Iran will be another event to keep an eye on, as escalation towards violence may send oil prices reeling through heavy support at 1.1500.

Aussie Looks Towards RBA Decision for Direction
The Australian dollar made a break for the .8100 level on Friday as a bout of US dollar weakness lent the high-yielding currency a boost. Nevertheless, traders have yet to truly shake their risk aversion as Iran continues to hold 15 British soldiers captive, keeping the scope of geopolitical risk wide. Furthermore, the US’s decision to tax imports of Chinese paper-products raises the potential of fiscal tensions between the trade partners. However, economic releases out of Australia failed to add significant volatility to the mix, as the data on hand was all second-tier in nature. Private sector credit edged slightly higher to 1.4 percent from 1.3 percent, signaling that the expansion of credit continues and may increase price pressures in the Australian economy. On the employment front, the ultra-tight labor market saw job vacancies decrease for the first time since November 2005 at a rate of -2.3 percent. Meanwhile, new home sales slowed to 2.9 percent, down from 5.9 percent during the month prior. However, the figure marked the third consecutive monthly rise as homebuyer confidence remained optimistic despite relatively high interest rates.

Economic news releases early in the week are likely to be mixed, as building approvals are predicated to rebound to 0.2 percent from -0.9 percent, indicating that homebuilders are still optimistic about the sector. Meanwhile, retail sales are anticipated to rise 0.4 percent while the trade deficit is forecast to widen to -1100M on booming domestic demand. The main event for Aussie, however, will be the Reserve Bank of Australia’s monetary policy meeting. While the central bank is widely expected to leave rates steady at 6.25 percent, traders may be on edge ahead of the decision as CPI still holds at a lofty 3.3 percent and creates the opportunity for additional Aussie appreciation. However, if the fundamentals point towards broad based cooling throughout the economy, traders may temper their expectations regarding any further RBA tightening and keep AUDUSD sub-.8100.

Kiwi Calendar Clears as Traders Bide for Direction
On balance, the New Zealand calendar seemed to be a strong proponent for kiwi strength. However, you wouldn’t have known that from price action alone. Setting up a considerable technical formation, NZDUSD initially rallied when traders returned from their weekends. Where was the cut off in the upward momentum? Exactly at 0.7200. Not coincidentally, this happened to mark a big double top – sharing the honor with the swing high from December of 2005. While the rejection of a big round number is not uncommon, the lack of a serious second attempt was – given the fact that eco data remained supportive throughout the week.

Considering Monday morning’s trade report, the initial rally was warranted. February’s deficit shrank more than expected to a -N$127 billion shortfall on the combined effects of a drop in imports and pick up in exports. A few sessions later, the first quarter measure of the Westpac consumer sentiment reported one of the few disappointing reports for the entire week just before NZDUSD found its ceiling. Realistically, the modest pullback in the proprietary report probably wasn’t the anchor on the kiwi’s steady move, rather it was the figurative easing on the RBNZ’s accelerator that put off the post-rate hike bullishness. As the data kept coming, so did the fuel for another rally. Building permits jumped the most six months in February, recalling RBNZ Governor Alan Bollard’s promise to keep a hawkish bias as long as consumer spending and housing trends drive inflation. Furthermore, an improvement in the fourth quarter current account balance and acceleration in money supply added their own level of support to the economy and speculation of another rate hike. Finally, on Friday, the real action began. Fourth quarter GDP ramped up to 0.8 percent, the fastest pace of growth in a year-and-a-half. However, the market seemed more concerned that the report marginally missed expectations as NZDUSD dropped 50 points almost immediately after the report.

As the market heads into a new week with no actionable indicators, it looks as if traders will have to decide a direction without the aide of a fundamental trigger. On the other hand, the still fresh GDP report may continue to play a role in action. The hammering the kiwi took after the report seems unwarranted given the considerable pace of growth. Therefore, as rational minds come back to the market, a relief rally may be the first line of duty. Another theme that needs no set time or date, yet can drive the kiwi with minimal effort, is the carry trade. Should risk aversion surge as oil prices rise or the Iran situation deteriorate, the kiwi could quickly become a target for sellers.

Boris Schlossberg is a Senior Currency Strategist at FXCM.