Dollar Down But Not Out- Reversal in the Making?
Friday’s US Non-Farm Payrolls printed at 88K slightly below the already muted expectations of 100K as US economy displayed clear evidence of deceleration. Every component of the report was worse than forecast with Average Hourly earnings growing only 3.7% vs. 3.9% consensus and manufacturing payrolls shrinking yet another -19K vs. -14K consensus. Furthermore, prior data was revised downward for the second consecutive month. Despite the less than impressive US results, the EURUSD was unable to muster much of a rally. As we have noted before, the currency pair was grossly overbought and traders needed to see recessionary-like numbers from the US employment report in order to propel the euro higher.

Still not all was bleak for the US economy. Earlier in the week both ISM Services and ISM Manufacturing surprised to the upside suggesting that US growth continues to be expansionary despite the negative impact of the slowdown in housing. In short while the greenback may be down, it not quite out. There appears to be no imminent threat of a recession in the US and with market sentiment so virulently dollar bearish, the greenback is primed for a reversal next week if it can find some support from fundamentals. Indeed on a technical basis the dollar index traced out an outside week suggesting that at least for now the selling may be done.

Next week the calendar provides plenty of event risk, starting with the FOMC decision on Wednesday. While no one expects the Fed to make a move either way, the persistently high level of inflation is likely to produce a decidedly hawkish communiqué, that will emphasize risks to price levels rather than economic growth. Should that tone be confirmed by hotter than expected PPI and buoyant Retail Sales on Friday, all the ingredients for dollar rally will be in place.

Euro Stalls
For the first time this quarter, Eurozone data began to disappoint. German sales printed a horrid –0.7% vs. 0.8% projected, although some of weakness was offset by gains in overall EZ Retail Sales number. Nevertheless, as we noted on Monday,” The decline in the latest Retails Sales reading means that sales in Q1 have dropped –2.9% on a quarter over quarter basis – a horrid performance from the 0.7% rise in Q4 of last year. The weak results should keep any ECB rate hike expectations capped at the 4.0% level at least until traders sees some concrete evidence of a pick up in consumption in the Euro-zone. “ The realization that EZ rates may not go beyond 4% kept a lid on all rallies for the rest of the week, especially , after German Unemployment and both PMI surveys printed softer than forecast suggesting that economic growth in the 13 member may have peaked.

Next week the EZ calendar contains only 2nd tier data, although traders will scrutinize the German Industrial Orders data to gauge the impact of the high currency on the region’ s key export sector. The marquee event, though one not expected to produce any changes, will be the ECB rate announcement on Thursday. Market forecast calls for rates to remain at 3.75% with a strong hint that the bank will move to 4% in June. If however, Mr. Trichet shows any hesitation regarding the tightening of monetary policy, the EURUSD could be in for a much more severe correction than the market expects.

Japanese Yen Ready for 121.00?
The Golden Week left USDJPY at the dollar’s whim this week, as sparse economic data gave the pair little to work with, leaving it to drift above 120.00. Labor cash earnings proved disappointing once again, falling -0.4 percent against expectations of -0.2 percent, reiterating that the economy may only be able to rely on the booming business sector for expansion, as stagnant wage growth continues to restrain consumer spending. These trends in wages have been especially confounding given the tightness of the labor market and the profitability of corporations. It appears that until businesses decided to invest in their workers via payrolls, consumption which represents more than 60% of Japanese GDP, will remain moribund.

Now that Golden Week is out of the way, a resurgence of Asian session trade Sunday evening could determine directionality for the rest of the week. The odds are stacked against the Japanese Yen, however, as Asian equity markets could rocket higher when liquidity floods back in following a record breaking week for US stocks. Moreover, the USDJPY has had a tendency to follow the Nikkei 225 Index, ramping up the possibility of a push up through 121.00. Fundamental data will only exacerbate yen weakness, as most releases during the week are anticipated to highlight the softness of the economy. First, the minutes of the Bank of Japan’s March policy meeting will likely be status quo, noting contracting prices and gloomy consumption figures, but remaining optimistic about future trends. Furthermore, BoJ Governor Fukui may even go so far as to say they will continue normalizing rates as soon as fundamental reports signal more steady expansion and prices. The leading economic index is forecast to rise to 40% from 27.3%, but given the fact the indicator has been marking contraction for four months, it will take a jump above 50% to make the markets believe that the economy is in the clear. The Eco Watchers “man-in-the-street” survey will face some of the same pressures, with factors such as tepid wage growth limiting the ability of the indicator to make its way much higher above 50.0. In all, barring a market-wide plunge of the US dollar, USDJPY looks ready to test 121.00 once again.

Pound Anxiously Awaits BoE Decision
The British Pound ended last week slightly lower, though the GBPUSD still attempted to hold the all-important 2.000 level as mixed economic data prevented major Cable losses. PMI for the services and manufacturing sector both eased back, but the declines were minute, limiting market moving potential. Meanwhile, there were multiple indications that UK housing sector growth remains hot, as PMI construction unexpectedly surged to 59.8 - the highest level in more than three years - as housing activity and employment growth both picked up. Although mortgage approvals eased back to 113K from a downwardly revised 117K, the figures still remain relatively lofty and signal robust demand for home loans. Other types of borrowing grew as well, as consumer credit kept pace at 0.9 billion pounds, led by a gain in credit card lending. This has all helped contribute to M4 money supply expansion of 12.8 percent for the year, which will likely remain a major concern of the Bank of England.

While this week has many UK market-moving indicators on deck, traders will be anxiously awaiting the BoE monetary policy decision. The central bank faces the strong inflation, which breached the 3 percent ceiling, consequently requiring BoE Governor Mervyn King to send a letter to Chancellor of the Exchequer Gordon Brown explaining how price pressures had built so much and how he planned on relieving them. This incident alone signals that the BoE will have to tighten policy, but the fact that housing growth has been relentless, credit growth keeps expanding, and consumption has remained resilient leaves the central bank even more leeway to take rates higher. Moreover, the BoE is known to surprise the markets, raising the question: will they go so far as to raise rates 50 basis points in order to quash inflation on the spot, or will they take the slower route and hike the usual 25 basis points? The release of indicators like Nationwide Consumer Confidence, Industrial Production, and the Trade Balance will help traders gauge Thursday’s potential rate action, but nevertheless, the decision itself presents substantial event risk for GBPUSD and will spark major volatility. If we see a hike in line with expectations, the British pound will likely gain at first, but could subsequently sell off as an increase to 5.50 percent is already priced in. On the other hand, a 50 basis point hike to 5.75 percent may send GBPUSD spiraling through the 2.0000 level to test new highs as interest rate differentials for the pair would jump in the favor of Cable.

Swiss Inflation Gets Hot
Switzerland today recorded the highest month over month inflation in 15 years as prices skyrocketed by 1.1% versus 0.9% projected. While the mountain economy has enjoyed some the best economic performance in the industrialized world, running unemployment rates as low as 3% while registering very respectable 2.2% GDP growth, it’s low yielding currency, plagued by carry trade sales has fallen to record lows against the euro. That weakness in the Swiss franc is clearly putting pressures on prices, especially energy costs and the highly conservative SNB must be alarmed by what it sees.

Indeed SNB President Jean Pierre Roth recently noted that "We will continue increasing interest rates to the full extent that is necessary in order to preserve price stability in the medium term." Many analysts believe that the 1.6500 EURCHF level represents the “line in the sand” for the Swiss Central Bank as it will not tolerate any further weakness beyond that point. With the cross having broached that barrier yesterday and with Swiss CPI now running much too hot for SNB’s comfort the market may now consider the idea of a 50bp rather than 25bp rate hike at the bank’s next meeting in June which should provide a much needed boost to the Swissie. Next week, the Swiss unemployment numbers which may print below 3% for the first time since October of 2002 will only fuel speculation of a larger rate hike as Swissie finally gets its due.

Canadian Dollar Carves out New Highs Against US Namesake
The Canadian Dollar was one of the top performers across major world currencies through this past week, gaining 0.8 percent against its US namesake. Relatively strong second-tier data did little to boost the currency’s cause, but traders nonetheless continued to cut Loonie shorts and sunk the USDCAD to its lowest since September of last year. Indeed, the CFTC Commitment of Traders positioning report showed that speculators turned net-long the Canadian dollar for the first time in six months. This is in and of itself very bullish for the Canadian dollar, but whether or not the Loonie may continue to carve out new highs will largely depend on upcoming economic data. Significant housing numbers and employment report promise high levels of event risk for the North American currency.

The Loonie’s inability to post a sustained break of the key 1.1050 mark may leave risks pointing to a short-term USDCAD bounce, but positive surprises in upcoming fundamental data may nonetheless prove sufficient to force further C$ gains. Monday’s Building Permits report and Tuesday’s Housing Starts survey will be first on the ledger, providing insight to the health of the domestic housing market. Significant disappointments in previous month figures leave many C$ bulls hoping that the most recent period will show a rebound. Much like its US counterpart, however, the Canadian housing market has shown consistently falling activity across the board. An uptick in Housing Starts could improve sentiment for the sector, but it would take a material surprise to shift the longer-term outlook. Thursday’s Trade Balance number likewise threatens volatility in CAD-denominated pairs, but the report may receive mere passing interest as forex markets prove indifferent to similar reports.

The true highlight of the week will come on Friday’s employment figures. Last month’s incredible 54.9k gain suggests that the Canadian labor market continues to expand at a healthy pace. Given consensus estimates of an additional 18.0k jobs, employment growth will likely continue to drive overall domestic growth.

Aussie Break May Prove False Without Fundamental Fuel
Like the kiwi currency, the Australian dollar broke below critical support read around 0.8200 last week. Interestingly enough, the side-by-side moves were prompted on different days and by completely different events; but they were similar in that they were both triggered by dovish turns from their respective central banks. Reserve Bank of Australia officials decided at the conclusion of their May 1st policy gathering to keep the overnight cash rate unchanged at 6.25 percent. Though there is always some intrinsic risk in the rate decision - no matter its ultimate conclusion or the expectations surrounding it – the market was wholly unimpressed by the pass. Heading into the meeting, economists fully expected the central bank to stand pat as government and proprietary inflation gauges pulled back within the official 2 to 3 percent target range. However, despite the conviction offered up by the official consensus, some in the market were holding out for a hike on the basis of strong domestic spending and sympathy to the RBNZ’s 25 basis point increase at its own meeting. Therefore, when the pass came through the wires, AUDUSD first made its dip below 0.8230 support. The genuine break came on Friday when the Quarterly Monetary Policy Statement revealed a softer outlook for inflation pressures.

While the initial break has been made, there hasn’t been enough time or distance covered to verify its authenticity. In fact, as the US session was winding down on Friday, a weak US dollar actually pushed AUDUSD back up above 0.8200. While this is a significant sign to any tape reader or technical trader, the pairs’ steady, two week downtrend has not even been tested by this as-of-yet fledgling retracement. The real action will begin this week, as a number of top market-moving indicators hit the wires and take sides. It may not take long to establish whether last week’s break was legitimate or not, since March and first quarter retail sales are due Monday evening. Aussie consumers are expected to have limited their visits to the shops through the month of March, though the quarter is expected to prove. This is an interesting situation give the Cashcard Retail Index for the same period actually reported an impressive rebound of 1.1 percent over the same period. If anything, this sets up the risk of a better than expected print and a bounce in the Aussie dollar. Another theme for the week will be housing. March building approvals and the first quarter House Price Index should give a read on consumer sentiment and spending on their most valuable assets. When all is said down though, the real event risk comes on Friday. Mimicking the build up in the US last week, the Aussie calendar ends with the employment numbers for March. Should the steady pace hold, it may keep the local currency buoyant.

Static Yield Differentials May Mark the turn in the Kiwi Dollar
The New Zealand dollar was one of the biggest losers among the world’s currencies on the week, with a rebound in its US namesake and similar declines in the AU$ sparking a Kiwi sell-off. There was relatively little economic data through the period, with a weak Building Permits report garnering relatively little attention across NZD-denominated pairs. Instead, the Kiwi currency moved in lock-step with its Australian counterpart, as a surprisingly neutral Reserve Bank of Australia Monetary Policy Statement dashed hopes of higher interest rates through the coming months. Combine this with an equally neutral RBNZ communiqué, and the carry trade Asia Pacific pairs may be in danger of losing their growing yield advantage over major counterparts. The recent bounce in the US dollar likewise leaves risks to the downside for the AU$ and NZ$, with short-term bearish momentum to possibly drive further declines.

The coming week holds significant Employment Data for the New Zealand economy, promising volatile moves on any surprises. The very recent Labor Costs survey may shed light on the prospects for Wednesday’s Unemployment Rate report. Wage costs came in slightly below expectations, adding to pre-existing evidence that inflationary pressures continue to ease in the New Zealand economy. Such a drop in income may likewise indicate that the domestic labor market is showing signs of slack. This is consistent with forecasts of an uptick in the jobless rate through Wednesday’s data release. Given a softening outlook on a previously unflappable labor market, it seems as though markets are growing increasingly aware of the notion that New Zealand interest rates will remain unchanged for the remainder of 2007.

Boris Schlossberg is a Senior Currency Strategist at FXCM.