Is the Dollar Doomed?
Is it “Welcome Back Cotter” time again? Yet another week of absolutely horrid performance from the US economy punctuated by a very weak GDP number that showed both stagnation in output and an increase in price level. The news stirred memories of when John Travolta was 50 pounds lighter and 30 years younger and the country was deep in the middle of stagflation of the ‘70’s. The greenback lost 50 basis points against the euro, and would have lost more save for the fact that the pair is so overbought that it triggered a wave of profit taking on Friday afternoon after reaching all time highs at 1.3686.

The tiny corrective rally notwithstanding, present situation looks bleak for dollar longs. Last week’s data showed further deterioration in the housing sector, a slip in the help wanted index and of course the near contractionary results of GDP which printed at 1.3% vs. 2.5% the quarter prior. Many analysts claimed that this quarter may have been the nadir for the year, but that argument seems rather dubious to us given the fact that consumer spending will likely suffer further from the housing unwind while defense and government spending which contributed mightily to the overall decline of the GDP numbers will come under additional assault from Democrats who are now in charge of Congress.

As always, the answer as to whether US economy has just made a soft landing or is on the verge of crashing hard into a recession will rest on jobs. Jobs are the critical component to the US growth scenario and are the last bastion of dollar bulls. As long as employment maintains expansionary pace, consumers should be able to generate enough income to service their ever mounting levels of debt. Therefore, the NFP will once again be key and traders will keep a careful watch on all of the preliminary reports this week including Chicago PMI, and both ISMs for any potential clues to Friday’s numbers .

Can Euro go to 1.40?
Despite soaring to record highs, the high euro exchange rate seemed to have little negative impact on the export sensitive EZ economy. All of the key economic metrics from Consumer Confidence, to IFO to Retail PMI data beat forecasts as the region’s economy continued to demonstrate impressive strength. The case for decoupling in which the European economic growth maintains a steady pace while US performance stagnates markedly is no longer a matter of conjecture but one of fact. The euro continues to benefit from the EZ superior growth levels and more hawkish monetary policy that is expected to elevate rates to 4.00% by June. Indeed, even the record exchange value of the euro against both the dollar and the yen appears to be of little concern to monetary and fiscal officials in the union as they downplayed its importance in public comments last week. Perhaps, given the surprising power of the economic rebound, EZ officials are willing to tolerate euro appreciation up to the 1.40 level. However their patience will be directly proportional to employment growth in the region. As long as the high euro does not crimp the improving labor market conditions, the sounds of protest from EZ politicians will be few and far between. If on the other hand EZ manufacturers begin to curb their labor force, due to completive pressures caused by the high euro, the political rhetoric will become decidedly less friendly.

To that end this week’s German and EZ unemployment data may prove to be quite instructive to the market. Traders anticipate a further decline in the German rate from 9.2% to 9.1% and if it is not forthcoming, the news may trigger a deeper retrace in the pair as markets reconsider the impact of the escalating exchange rates. Ultimately however, it will be US jobs that will likely determine the outcome of trade this week. If US data disappoints the euro may gain regardless of any labor problems of its own.

Golden Week Holiday Leaves Yen to Dollar’s Whim This Week
After trading in an ultra-thin range for much of the week, USDJPY finally broke out to the upside on dollar’s dead cat bounce. Yen remained weak for the remainder of the week, especially as CPI data showed the economy continued to slip towards deflation, industrial production faltered, and retail trade pointed to even more dismal consumption trends. Markets turned their attention to the Bank of Japan’s policy meeting, and while the central bank left rates steady at 0.50 percent as expected, Yen saw a brief jump after BoJ Governor Toshihiko Fukui said that the Bank needed to raise rates even when gains in consumer prices are modest, as long as they are confident that growth in the Japanese economy is sustainable. Nevertheless, he acknowledged that the pace of rate normalization has been slow because of "weak" inflation and that the pace of rate hikes will be gradual.

Next week is Golden Week in Japan, leaving the economic calendar remarkably sparse with only labor cash earnings scheduled for release. The figure is anticipated to improve mildly to -0.7 percent, but with payrolls still stagnating or contracting, the outlook for consumption growth remains bleak. However, there is little reason for wages to remain so tepid, as Japanese companies have outperformed nearly every quarter. While it is apparent that firms have invested heavily in their own interests, it has also become clear that they need to divert some investment towards employees. This disconnect should keep yen from making any powerful gains this week, but technical factors may be working in favor of a USDJPY decline. In fact, the recent ascent faces resistance just above at the April 16th highs of 119.85, not to mention the psychologically important level of 120.00. Furthermore, thin Asian trade could leave the pair to move primarily on dollar sentiment, which may remain bleak in the face of potentially dismal NFPs next Friday, possibly leaving USDJPY bears in charge next week.

UK Data Unlikely to Break Cable from Critical Levels
The British Pound ended the week slightly lower, though the GBPUSD still hugged the all-important 2.000 level as economic data underpinned a Cable bid. While UK expansion in the first quarter slowed slightly to 2.8 percent from 3.0 percent, GDP hit the tape a bit stronger than expected at 0.7 percent for the quarter. The gain was led by the services sector, while industrial production detracted slightly – not entirely surprising as the manufacturing sector has long struggled in the UK. Meanwhile, Nationwide House Prices surged 0.9 percent, as steadily gaining real estate prices point to strong demand for housing. The recent Nationwide reading represents the highest levels in four months, with housing prices only adding to existing pressures on the Bank of England to tighten monetary policy.

Economic indicators on tap for the UK should maintain expectations for a hawkish policy stance by the Bank of England when they meet on May 10th. GfK Consumer Confidence is expected to rise to -7 from -8, signaling that sentiment amongst households is improving. Subsequently, PMI for both the manufacturing and services sector are forecasted to fall back. However, the moves are anticipated to be so minute, they will do little to sway central bank expectations. Barring a major surprise in the scheduled economic releases, GBPUSD will likely range trade throughout the week, but Friday could prove explosive as key US data will be released and could help bring Cable to tumble from these critical levels.

KOF Keeps Swissie Contained
Much to the dismay of Swissie longs the KOF index of leading economic indicators failed to print at 2.00 as forecast dampening any expectations of a possible 50bp rate hike by the SNB. The measure did register at 1.90 improving over the past month reading of 1.84 essentially assuring a 25bp raise at the next meeting in June. However, given the torrid pace of growth in the mountain economy which has seen strong gains in Retail Sales and near record low unemployment, traders had hoped that a very high print from KOF would prompt the SNB to tighten further and compress the interest rate differential with the EZ. With possibility of such an event now remote, the market plowed right back into the carry trade taking EURCHF to within a few pips of the 1.6500 level.

Although some analysts have speculated that 1.6500 in EURCHF may represent the “line in the sand” for SNB as the Swiss monetary officials begin to worry about the increasing dangers of imported inflation into the country, so far evidence of inflation has been scant. That’s why this Thursday’s CPI data may hold special importance as the price level is expected to skyrocket to 0.8% from 0.1% the month prior. Should that estimate prove accurate or worse print even hotter, talk of a 50bp hike will be quickly revived and the 1.6500 EURCHF level may be history as traders begin to unwind their longs.

Canadian Dollar Pushes Higher As True Event Risk Looms
Though monetary policy decisions always carry some level of inherent event risk, the Bank of Canada’s meetings seem to have become a mere formality for the currency market. With this in mind, it was no surprise then that the monetary authority didn’t cause any turbulence in the markets last Tuesday by announcing the overnight lending rate would go untouched from its 4.25 percent roost. On the other hand, this rate decision had a little more to it than the typical pass. A few days later, Governor David Dodge and his BoC colleagues released the April Monetary Policy Report. The brief statement repeated most of the same themes policy makers have given voice to in past months. Growth was given a clean bill of health as the bank touted domestic demand as the main engine and exports to the US as the slow break – nothing we haven’t seen before. Growth projections were trimmed slightly due to expectations of a prolonged US slowdown. Expansion is expected to average 2.2 percent this year and accelerate to 2.7 percent for the following two years. On that same note, there was a little more interest in inflation trends. With CPI hovering around 2.3 percent (above the target 2.0 percent), officials said inflation projections were “roughly balanced” but with a “slight tilt to the upside.” While this is not a dramatic change, it does break up the monotony and suggests ‘rate hike’ is still in the their vocabulary.

In the week ahead, the market is looking at data with much greater market-moving potential. February GDP released on Monday will star the markets off right. Economists predict expansion over the month ran a reserved 0.2 percent, which would line up nicely with the MPR’s projection for this year. At the same time, surprises are not uncommon for this indicator and a big one could set the loonie in motion. The possibility of a big move is particularly notable give the relative spot levels of USDCAD before the indicator hits the wires. Traders are at an impasse, deciding whether or not to extend the Canadian currency’s steady run to a fresh seven-month high against the almighty greenback. On the one hand, a read that comes in line or prints better than expected could easily recharge the loonie’s steady run. On the other, a disappointment could give additional weight to the ‘oversold’ sentiment that perpetual bulls have been crying out about for weeks. However the indicator prints and traders respond, the growth number could easily influence price action for most of the week – that is until Friday. On the final trading day of the week (while most of the currency market is tuned into US NFPs), the Canadian docket will release the April Ivey PMI. Expectations for the gauge of factory activity are running low, noticeably adding credence to a USDCAD bottom.

Risks Remain to the Downside for Further Aussie Moves
Critical Australian Consumer Price Index data sparked pronounced AUDUSD declines, with non-existent price pressures virtually ruling out higher domestic interest rates through the medium term. Markets were first warned of the impending CPI disappointment with a lackluster PPI report; given median forecasts of a 0.6 percent quarter-over-quarter gain, the production-linked price index stayed exactly unchanged through Q1, 2007. The combination of PPI at 0.0 percent and CPI at 0.1 eliminated hopes that the central bank would take rates to 6.50% through the coming week’s announcement. The Aussie instantaneously fell to two-week lows of 0.8234, but a later US dollar tumble allowed the currency to retrace all of its post-news losses. The currency is not out of the woods yet, however, with the key RBA Quarterly Monetary Policy Statement to guide expectations for any future interest rate changes.

Given that the RBA is exceedingly unlikely to raise rates through its Tuesday announcement, true event risk will be limited to Thursday’s Trade Balance and Quarterly MPS reports. Neither event is likely to lift the currency beyond current lows, as an exceedingly high AU$ exchange rate will limit Trade Balance recovery and the RBA is unlikely to prove hawkish in its stance on inflation. Of course, the market has arguably priced in disappointments in both figures—leaving scope for an AUDUSD rally on positive surprises. Whatever the outcome, the coming week promises to be a volatile one across AUD-denominated pairs, with short-term bearish momentum leaving risks to the downside for further AUDUSD performance.

Rate Hike and Equity Rallies Not Enough to Spark NZD Gains
It’s been a wild week in Kiwi trading, as a surprise interest rate hike was not enough to drive sustained NZDUSD rallies. In fact, the opposite was true; despite the RBNZ’s decision to raise rates ahead of market expectations, the NZDUSD saw its first weekly decline in nearly two months. An extra 25 basis points in yield and continued rallies in global equity markets proved insufficient to keep the Asia-Pacific currency bid. The drop was i caused n part by a strong US dollar rebound, but the fact remains that the high-flying NZDUSD failed to advance on bullish price developments. Central bank rhetoric was likely to blame for the bearish turn; the official Reserve Bank of New Zealand communiqué made no reference to the future of interest rates and instead noted the “unjustifiably high” NZ$ exchange rate. Given that currencies tend to move on changing and not static interest rate differentials, it stands to reason that stable rates at 7.50% would not necessarily lead to a continued NZDUSD advance. Furthermore, RBNZ Governor Allan Bollard’s reference to an “unjustifiably high” exchange rate led to fears of central bank intervention—leaving one more reason to sell the Kiwi through Friday’s close.

The coming week should be comparatively tame for the New Zealand Dollar, but markets have since been left to wonder whether the Kiwi can rebound and continue to rally despite recent developments. Noteworthy economic data will be limited to a Building Permits survey, with little scope for upward surprise leaving few hopes for a subsequent NZD rally. Instead, the New Zealand currency will be left to trade off of sympathetic moves to the Australian dollar on the upcoming RBA interest rate announcement. Stable interest rates for the Australia economy may look to add to the recent bearish sentiment for the popular carry trade pairs, leaving risks for the second consecutive week of Kiwi and Aussie declines. From a technical perspective, the NZDUSD’s inability to breach the psychologically significant 0.7500 mark likewise leave short-term bearish momentum intact through upcoming trade.

Boris Schlossberg is a Senior Currency Strategist at FXCM.