Running Away From the Dollar
EUR/USD hit a 2007 high this week as the market continued to run away from the greenback ahead of the G-7 meeting. On a week when the economic calendar carried little news of import, the order flows were driven mainly by political considerations. As we noted on Friday, “Although, the US policy actions up to date have been miniscule in their economic impact, speculators are taking no chances and continue to move capital out of dollars ahead of the G-7 for fear that US rhetoric [over trade with China] may only grow more strident. The fact China is not attending this week-end’s meeting has only exacerbated those concerns.”

However, the markets may be overreacting. China and US remain inextricably tied to each other with Chinese needing access to US consumer markets and US in constant demand for Chinese capital. In short, unless the US protectionist rhetoric actually turns into protectionist legislation the danger to the dollar may be overblown. Nevertheless, next week may only bring limited relief to dollar bears. The calendar starts with US Retail Sales on Monday, which may be the sole positive piece of news for the greenback if the report beats consensus. The problem of a consumer slowdown has been dogging the US economy ever since the blow-up in the sub-prime housing sector. Note last week weak U of Michigan data which printed at its lowest level since August of 2006. Yet what consumers say and what they do tends to be quite different. Therefore a boost in Retail Sales would dispel some of the dour sentiments surrounding the prospects of future US growth. Still housing will return to take focus next week as both NAHB and Housing starts data hit the tape and expectations are for further declines. Overall the offers little hope of a dollar rally unless the data surprises to the upside.

ECB Puts on the Brakes
On Thursday we wrote,” the question remains open however, whether Mr. Trichet will choose to be so direct this time or whether he may prefer to have the flexibility to postpone the decision until the June meeting. With the euro trading at record highs against the yen and the Swiss franc, bolstered by the insatiable carry trade demand, the European monetary authorities have good reason to try to slow down the appreciation of the currency. Although German and French Industrial demand appears healthy, seemingly unaffected by the rise in the exchange rates, Italian Industrial Production fell for the second month in a row and may be a precursor of the more difficult economic environment for the Euro-zone producers should the euro rally further. Furthermore, it is becoming increasingly clear that Japanese monetary authorities will maintain a neutral stance until well past the June Parliamentary elections, therefore the only way for the ECB to slowdown the EURJPY juggernaut is to delay the rate hike until June which should push some of the short term speculative capital out of the pair. “

Mr. Trichet, did indeed keep rates on hold and furthermore did not provide any unequivocal assurances that the ECB would tighten in May. Nevertheless, traders continued to rally the euro, as the buying frenzy took on a momentum of its own. The strength in the EURUSD comes from the unwavering belief that ECB will continue to hike rates past 4% and from the desire of many markets players to diversify out of the dollar. With the EURUSD within striking distance of all time highs, these two forces may be strong enough to push the pair through the stops at the 1.3640 peak. However, the question of how much further the euro may rise is likely to rest with the US data. Next week’s European calendar is nearly empty with only the second tier ZEW of any interest to the market. Therefore, the currency’s rise is very likely to be contingent on continued poor results from US economic docket.

G7 Warnings On Risk Could Unwind Carry Once Again
The Japanese Yen traded relatively quietly throughout last week after the Bank of Japan’s decision to leave rates steady came as no surprise to the markets. However, Yen initially spiked higher as the central bank said, "Japan's economy is expanding moderately,” while maintaining that inflation will be flat at zero percent on a year over year basis. With no immediate threat on the price front, the BoJ monetary authorities are likely to remain neutral throughout most of 2007. The end of the week saw a bout of volatile trading, though, as USDJPY plunged below 118.50 early Friday before swiftly returning above 119.00. The culprit: G7 jitters following ECB President Jean-Claude Trichet comments on Thursday saying that the Yen should follow fundamentals. While this kind of speculation ahead of the G7 meeting is quite typical, the communiqué has failed to specifically mention the low-yielding currency in the past. If history is to be our guide, however, we look to the last G7 session in Essen, Germany in February. In the days running up to the meeting, USDJPY rallied over 100 points to close out the week just below 122.00. However, once the commencement of the meeting yielded no commentary on Yen, but focused on the risks associated with “one-way bets,” carry trades unwound swiftly as USDJPY sold off nearly 200 points over the course of the following week.

This time around, hedge fund risks are scheduled to be discussed, which could add a risk-averse tone back into the markets, especially if the G7 Finance Ministers issue a stern warning on the dangers of highly leveraged investments. On the other hand, a spate of weak economic releases are due to hit the tape over the course of the week, with both the manufacturing and services sector both anticipated to show slower activity, while consumer sentiment is forecasted to ease back, despite the recent rise in the Eco Watchers “man-in-the-street” survey. Nevertheless, international issues tend to prevail over fundamentals when it comes to the finicky carry trade, giving USDJPY the opportunity to drop below 118.50 once again.

Pound Enjoys Tax-Free Repatriation Chatter As BoE Speculation Grows
The British pound surged against the benchmark US dollar last week as a result of both of cross currency flows and its own fundamental momentum. Looking at the economic calendar for the period ex ante and post facto, there were few indicators promising much in the way of market movement. The RICS Housing Price Balance for March put an end to four months of consecutive decelerations after crossing the wires at 25.5 percent. However, this was hardly ground breaking evidence of a bullish resurgence in the lagging housing sentiment gauge. Elsewhere, the visible trade account for February undid any good will the pound was receiving purely on economic data. The deficit widened unexpectedly to £6.791 billion, which in itself is not a significant record though it may reveal the detrimental effects of an expensive currency on exports. Perhaps the most useful report from the short list of data was the BRC Retail Sales Monitor which rose 6.2 percent in March from a year ago. While this was a strong pace of growth for the proprietary gauge, its real value is realized as a speculative tool for the government retail sales gauge due at the end of this week.

Data aside, the real fundamental action over the pervious trading period was garnered from an article that ran in the Financial Times. According to the piece, the Treasury is mulling over a decision as to whether it will allow British-based multinational corporations to repatriate foreign profits tax free. While officials have said that this is not breaking news since policy officials have been in talks with businesses for over a year, it was taken as a particularly prescient article when the sterling is on its bullish path. The Treasury has said it will release a consultation paper to illuminate the issue sometime this spring.

Unlike the previous week, the pound will be inundated with event risk over the coming days. The ubiquitous housing indicator will signal the start of trading with the leading Rightmove Prices gauge. However, the next few days is when those slow on the trigger will really get bogged down. Monday, the PPI input/output numbers will give traders just a taste of the inflation main course – the following day’s CPI and RPI. The consumer gauge is dangerously close to its highs, but it is the retail price index that hit its fastest pace since 1991 in February. All the data has to do is hold rank and speculation over a rate hike will raise itself. On Wednesday the claimant count rate and earnings numbers will add another facet to inflation expectations; but it will be Friday’s retail sales that truly draws attention to the consumer.

Swissie Likely to Keep In Lockstep With Yen
The Swiss franc made significant gains this week; however, the drop from 1.2250 down to 1.2050 has little to do with fundamentals as USDCHF rode the wave of the other major low-yielder, USDJPY. Nevertheless, the drop in Switzerland’s unemployment rate down to a four year low of 3.0 percent from 3.2 percent was impressive, as the country’s economic engine keeps on ticking. Indeed, demand for Swiss products in the Euro-zone have led manufacturers to boost output, thus requiring additional workers in factories. With the labor market tightening further and further, consumption growth – which already makes up a large portion of GDP – should continue to fuel expansion in the country. Although estimates for economic growth this year are much lower than last year at 2.0 percent and inflation remains tepid, the Swiss National Bank may consider continuing on their path of normalizing interest rates as investors are pricing in two more hikes this year, which would bring the benchmark to 2.75 percent by year end.

Price action for the Swiss franc will likely remain contingent upon movements in the Japanese Yen following the release of the G7 communiqué this weekend. While the meeting isn’t likely to yield any earth shattering news, carry trades could be vulnerable to commentary regarding “one-way bets” or highly leveraged trades. Data-wise, the Swiss calendar is fairly thin. The often-volatile, rarely market-moving release of Adjusted Real Retail Sales isn’t likely to deviate from the norm, as the expected decline to 4.0 percent still points to healthy consumer spending. Meanwhile, Producer and Import Prices are forecasted to gain 0.3 percent once again in March, as higher oil prices should give factory gate costs a boost. Should the release truly reflect mounting price pressures, USDCHF bears will only be given additional incentive to take the pair sub-1.2100.

Core Inflation May Leave Risks to Downside for Canadian Dollar
The Loonie continued to rally under the force of previous macroeconomic momentum, as it reached fresh 5-month highs despite worse-than-expected Housing and Trade Balance figures. Indeed, there was seemingly little to stop the currency’s gains; a softer Housing Starts result was unable to slow an impressive single-day Canadian dollar appreciation against its US namesake. A notable drop in Friday’s Trade Balance surplus produced a small bounce in the USDCAD exchange rate, but it remains decidedly unlikely that the Loonie will continue lower on the disappointing February number. Net exports fell 17 percent from January due to a domestic railroad strike. With goods unable to reach their intended destination, the headline Surplus result seems misleading and will likely be erased by March gains. The labor strike will also have detrimental effects on Tuesday’s Manufacturing Production results, but later week data is expected to show strength in key sectors of the Canadian economy.

Key consumer inflation and retail sales reports highlight event risk for the world’s eighth largest economy, while a slightly lesser International Securities Transactions release may likewise drive CAD-denominated currency pairs. Loonie bulls hope that a strong Consumer Price Index result will continue to drive speculation of stable interest rates through the medium term. Last month’s jump in headline and Bank of Canada Core CPI scaled back expectations of central bank interest rate cuts through the second half of 2007. This led to an instant spike in bond yields and a similar rally in the Canadian Dollar. Markets now expect that month-over-month CPI continued at a robust 0.5 percent, with sharp gains in gasoline prices driving overall inflation higher. There exist risks to the Core measure, however, with soft growth at 0.2 percent hardly indicative of strong inflationary pressures. All eyes will turn to the significant data and drive the Canadian dollar accordingly.

Aussie Braces for Next Week’s CPI Report
The Australian dollar continued its winning ways, surging to 17-year highs on global demand for high-yielding currencies. A softer-than-expected Employment Change led to a very short term AUDUSD drop, but it was clear that unemployment at 4.5 percent would hardly produce extended Aussie declines. Indeed, labor market strength has produced a good deal of optimism for greater Australian economic growth—leading to speculation that wage price inflation will likewise push interest rates higher through the medium term. The Reserve Bank of Australia left its interest rate target unchanged at 6.50% through its April meeting, but continued strength in AUD-denominated currency pairs underlines the fact that traders expect the central authority to tighten at its upcoming announcement. Economic data for the coming week will be limited, but markets will brace for the following week’s first quarter Australian CPI report.

Noteworthy event risk will be limited to Thursday’s trade-linked price indices reports, with second-tier motor vehicle sales data unlikely to elicit reactions in AUD-denominated currency pairs. Current forecasts show that economists expect both figures turned lower through the first quarter. With a higher domestic exchange rate, the Australian consumer likely paid considerably less for imported goods. Likewise, any appreciation in commodity prices will be offset by the AU$’s gains against its US namesake. Absent any material surprises in either figure, currency traders will have to wait until the upcoming Consumer Price Inflation report—virtually guaranteed to guide expectations for the future of short term interest rates.

CPI Report to Guide Interest Rate Expectations for NZD
High-yielders continued to dominate currency market flows and the New Zealand dollar was no exception. The Asia-Pacific currency rallied to 25-month highs against its US namesake and just points short of multi-decade highs against the Japanese Yen. A late-week Retail Sales report increased the attractiveness of the New Zealand dollar; an astounding month-over-month 1.9 percent gain in the spending figure underlined truly robust demand within the economy. The result instantly served to send domestic yields higher—boosting the Kiwi’s strong advantage over major counterparts. Expectations of further interest rate gains will only serve to keep the currency bid through the short term, but this may all depend on the coming week’s Consumer Price Index report.

Given such strong upward momentum in consumer-linked data, markets now expect that first quarter CPI data will further boost the case for RBNZ rate hikes through the first half of the 2007. Current market forecasts of a 0.5 percent first quarter gain trump the RBNZ’s expectations of 0.3 percent and underline price risks for the domestic economy. Central bank officials argue that prices will remain subdued through the medium term and turn higher in 2008. As such, an uptick in first quarter CPI growth may shift expectations for the path of RBNZ monetary policy tightening. A changed timetable for interest rate hikes would certainly show its effects on the domestic currency, with the Kiwi likely to react to any and all surprises in the Q1 CPI report. Otherwise, overall market flows and appetite for risk will continue to drive high-yielding currency flows.

Boris Schlossberg is a Senior Currency Strategist at FXCM.