Dollar Holds Its Ground
On Wednesday we wrote,” The EURUSD continues to range trade between 1.3450 and 1.3650 and will likely remain contained within that zone unless one or the other of the following factors becomes clear to the market – 1). ECB willing to raise rates beyond the 4% level or 2). US economy tipping into a recession. Neither one of those scenarios can be forecast with any degree of certainty just yet which explains the meandering price action in the pair this week.”

Indeed much to the dismay of dollar bears US data was surprisingly strong, led by a very healthy rebound in Industrial Production which increased 0.7% vs. -0.2% the month prior. The second consecutive sub-300K print in weekly jobless claims also served as a strong counterargument to the doomsday scenarios of massive unemployment caused by the housing slowdown. In short, the news of dollar’s death has been greatly exaggerated. The unit continues to hold its ground as US economic data is not nearly as dour as the market expected.

Next week the calendar is sparse but it contains key data from the housing sector. In order for dollar bulls to make more progress the housing data must show some signs of stabilization. Last weeks very low reading from the NAHB which dipped to 30 from 33 expected provides little positive news for greenback bulls. Nevertheless if sales of New and Existing homes show even a slight improvement, the dollar could see further strength as the recession hypothesis becomes less and less likely.

Will Sentiment Support the Euro?
The euro ended the week almost completely unchanged this week, even as data signals that Germany remains the picture of health and the European Central Bank is prepared to hike rates in June. Better-than-expected economic releases have done little to boost EURUSD significantly, as interest rates of 4.00 percent are already priced into the pair, but they did manage to stir up a bit of price action as the euro managed to breach 1.3600 on the back of German GDP. Expansion in the Euro-zone’s largest economy surged 0.5 percent in the first quarter, while the annual rate held at a resilient 3.6 percent, as exports provided a huge boon. However, a consistently tightening labor market has not necessarily led to an influx in consumption, as demand was hampered by German Chancellor Angela Merkel’s VAT hike in January. Meanwhile, CPI for the Euro-zone held aloft at 1.9 percent against expectations of an easing to 1.8 percent. With growth going unfettered and price pressures persisting, there’s no doubt the ECB will move 25 basis points higher next month. The question is: what will they do after that?

Event risk out of the Euro-zone is filled with sentiment reports this week, as the ZEW, IFO, and GfK surveys will all be released. The ZEW and IFO releases are both anticipated to reflect growing optimism amongst investors, as equity markets continue to reach new highs and businesses throughout the Euro-zone outperform. Meanwhile, consumers are forecasted to show more confidence in the economy, as labor market conditions are perpetually improving. Not to be forgotten, industrial new orders are predicted to rebound, as German trade data has proven that export demand is still strong despite the appreciation of the euro. With a rising trendline and Fibonacci support lying below at 1.3482, EURUSD will have a tough time falling lower, and surprisingly strong fundamentals may push the pair up to 1.3600.

Yen – Little Help from the Yuan
“Another night of trade in FX, another drop in the Japanese yen,” we wrote on Thursday. “The lowest yielder in the G-3 universe was hurt tonight by less than stellar GDP results and persistent inaction on the part the BOJ. Japanese GDP printed at 0.6% vs. 0.7% expected and although this was the ninth straight quarterly increase it provided no reason for the BoJ to expedite its “low and slow” approach to monetary policy and as such disappointed speculators betting that a more robust number would compel the central bank to hike rates soon.”

Yet on Friday the Japanese currency received an unexpected boost as PBOC announced that it would widen the Yuan/dollar trading band from 0.3% to 0.5% and raise rates by another 18bp. The rally was short lived however as the pair quickly regained the 121.00 level with carry traders plowing back into the market. Nevertheless, the announcement by the Chinese may have long term ramifications as we noted in our analysis of the move (http://www.dailyfx.com/story/topheadline/Chinese_Yuan_Band_Widens___1179507718988.html) As we wrote, “This policy change is just the latest attempt by Chinese authorities to reign in speculative sentiment in the country by slowing inflationary pressures. In the meantime the announcement should provide a short term boost for the yen and serves as just the kind of exogenous news event that we warned about earlier this week when the currency was being sold relentlessly by the carry traders. While it may be too soon to call a near term peak in USDJPY, tonight’s news certainly provides yen bears with reason for pause as the unit may now find a bid despite the woeful Japanese fundamentals.

Next week, the Japanese calendar holds two events of possible interest to the market: Trade Balance data and National CPI figures. However, currency traders will most likely be glued to the movements of the shanghai index on Monday. If Chinese equities fall in response to the PBOC action, the USDJPY may do so as well.

Pound Shows Clear Signs of Slowing, Can Declines Continue?
The British Pound lost against most major currencies on the week, as a bullish employment report was not enough to save the currency from a post-Consumer Price Index tumble. The Bank of England’s preferred measure of inflation showed a 2.8 percent year-over-year rate through April, a noteworthy drop from March’s 3.1 percent reading. This in and of itself was enough to leave short-term yields slightly lower, as some had hoped a headline rate at or above 3 percent would significantly boost the likelihood of more monetary policy tightening through the medium term. The next day’s Jobless Claims Change came in considerably higher than expected, leaving the Claimant Count rate at its lowest in two years. Yet the initial market reaction was not as bullish as some would hope, given that headline Average Earnings numbers printed at 4.5 percent versus 4.8 forecast. The subsequent Bank of England Report on Inflation did little to heighten expectations for further hikes. Though the central bank implied that the short-term lending rate could see another 25 basis point rise through the end of the year, they showed little fear of rising inflation through the same period.

Interest rate futures are currently pricing in a very strong possibility of a further 50bp in monetary policy tightening through year-end, leaving little room for further yield-based GBP appreciation. Friday’s weak Retail Sales numbers placed further doubt on the future of rising rates; consumers unexpectedly slowed spending through the month of April. Indeed, a deceleration in Retail Sales growth will only ease the bank’s fears of overheating consumption. The question now remains whether the GBP may be able to hold its year-to-date gains, but the coming week of data will provide relatively little new insight on the strength of Europe’s second-largest economy.

Significant event risk for the coming days will be limited to Wednesday’s Bank of England Minutes and an end-of-week revision to advance GDP estimates. There will be considerably less uncertainty surrounding the BoE minutes, however; the Bank was clear to highlight much of its opinions on the future of monetary policy in its recent Quarterly Report. Pound bulls nonetheless hope that the minutes show BoE MPC members voted 8-1 to hike rates on May 10th. The actual text will likely draw little interest, but the MPC does in fact highlight notable arguments for and against specific monetary policy decisions. Unsurprising rhetoric will leave the Sterling to trade off of the next day’s CBI Industrial Trends figure and end-of-week GDP revisions. There is little reason to believe that either event will surprise, but a downward adjustment to first quarter GDP numbers would almost surely spark immediate GBP declines.

Swissie May Prepare To Turn On Strong KOF
In a week that was not atypical for Switzerland, the economic calendar proved very thin with only Adjusted Real Retail Sales released. The figure surprisingly jumped to 7.6 percent in March from 4.5 percent in the month prior, led by strong sales for clothing items, as an ultra-tight labor provides disposable income for consumption. While the data is encouraging for the retail sector, the greater conclusion to draw is just how resilient the Swiss economy is as a whole. While regions such as the US and Euro-zone work to combat a mixture of slowing growth and mounting inflation, expansion in Switzerland has remained above 2 percent while price pressures have been tepid. However, this has been of little benefit to the Swiss franc, which continues to get battered with the Japanese yen due to its low-yield status – a relationship that is unlikely to stop until the Swiss National Bank successfully normalizes rates to a competitive level.

This week, event risk in Switzerland will be relatively high, with the most market moving piece of data hitting the tape on Friday. The KOF leading indicator is anticipated to be quite encouraging given the resilience of consumption and trade, and with the SNB stating their desire to continue normalizing rates, a strong KOF figure may bring traders to price in a hike on June 14. The other indicators coming out during the week, including producer and import prices and employment, are anticipated to back the SNB’s bias, as they could signal that consumer price growth remains positive while strong employment levels persist. Given the heavy resistance levels looming above at 1.2286, USDCHF looks ready to turn lower to at least 1.200, and the fundamentals at hand will likely perpetuate this move.

Canadian Dollar One Step Closer to Parity
The Loonie finished substantively higher for the 8th week of the past 9, setting fresh multi-decade highs on overwhelmingly bullish sentiment. USDCAD saw little relief as Monday sparked immediate declines; a strong Manufacturing Shipments report set the tone for the rest of the week’s trade. Later data was even more bullish; a strong CPI report kept the ball rolling ahead of Friday’s impressive Retail Sales release. The Bank of Canada Core inflation rate reached its highest in over four years and sent Canadian bond yields and short-term market interest rates flying higher. Synthetic interest rate futures currently price in a 100 percent chance of a Bank of Canada interest rate hike through year-end 2007, lending crystal-clear support to the domestic currency. In fact, the CFTC Commitment of Traders report showed that speculative traders were the most net-long the Loonie since February of 2006. Positioning is slowly becoming extreme in the Canadian Dollar’s favor, which in and of itself may slow the currency’s recent gains. Yet the net-longs are still below December 2005’s record highs, suggesting that the currency may continue higher yet before making a substantive turn.

The upcoming week promises little USDCAD volatility on a relatively empty calendar, but conditions may be setting up for Loonie consolidation before any moves higher. Indeed, event risk will be limited in both the US and Canada, leaving relatively little fundamental fuel for further CAD advances. On Monday Canadian markets will be closed for Victoria Day, while Wednesday holds the only noteworthy economic data on the week. The Leading Indicator report is expected to show strong expansion prospects for domestic commerce, consistent with a previously robust print. It would likely take a material surprise to force large moves in currency markets, however, leaving CAD traders to trade off of developments in the US and global commodity exchanges.

Aussie Shows Clear Bearish Potential
The Australian fell further away from recent 17-year highs, as a soft Wage Cost Index report hurt chances of higher interest rates through the medium term. Implied short-term yields reached their lowest since last week’s Employment report, but futures traders still show full expectations of a 25 basis point Reserve Bank of Australia rate increase through year-end 2007. Whether or not such a hike comes to bear will largely depend on future economic data, but such forecasts will help prop the high-flying currency through the medium term. Of course, such fundamental boosts will amount to little if the US dollar continues to rebound from multi-year lows—removing a key source of AUDUSD rallies. Global metals markets have likewise placed downward pressure on the AUD, as a break of a long-term uptrend in Gold threatens to further sink the Australian currency. Speculative positioning, as reported by the CFTC, continues in extreme territory in favor of AUDUSD longs. Taken into perspective, such overstretched one-sided positioning leaves little room for further appreciation.

The coming week should be comparatively tame for the Asia-Pacific currency, with second-tier data unlikely to cause large moves across AUD-denominated pairs. Instead, look for broader market flows and the performance of risky assets to guide the Aussie through the shorter term. Continued rallies in global equity markets will, all else remaining equal, support the carry-trade favorite. But it will be important to see whether Gold futures can recover from the past week of declines. The precious metal’s recent break below a multi-month uptrend line may force further losses—stripping the gold-rich country from a key source of demand for domestic production. According to our Technical Currency Analyst Jamie Saettele, the Australian Dollar will see little meaningful support until 0.8028. A substantive bounce off of this level may produce a final challenge at multi-decade highs, but the currency may be on its last legs if economic data does not surprise consistently to the topside through the medium term.

New Zealand Dollar Left In A Lurch With Rates Still Up In The Air
Rate hawks were receiving mixed signals from this past week’s economic calendar. On the one hand, the central bank’s two key components for monetary policy championed the call for another rate hike. On the other, another inflation indicator pulled back from its stress point and politicians joined policy makers in making the effort to talk the national currency down. Always starting with the bullish pressure, the front half of the docket was kind to the kiwi beginning with the Real Estate Institute of New Zealand’s housing data. According to their survey, housing sales rose 8.1 percent over the year through April. More pertinent for policy makers concerned about medium-term inflation, the inflation component surged 14 percent over the same period for a record increase. On the same day, Statistics New Zealand took a read on the other artery for rate pressure – domestic consumption. Retail sales over the month of March cooled from its 2.1 percent pace the month before, but was well above expectations of a modest contraction with its 1.3 percent increase. While this was a promising number overall, the broader quarterly figure was where the action was. Spending rose 3.8 percent over the first three months of the year, the most since records began back in 1995. When the busy Monday finally passed though, sentiment changed drastically. The first quarter producer price measures confirmed the weakness reported in CPI over the same period. Input prices plunged 1.6 percent, the biggest decline on records going back 30 years, as energy and import costs declined. A day later, Finance Minister Cullen delivered the national budget with a number of warnings. He said that monetary policy was “causing unnecessary stress on the export sector” and went on to say his piece on the high rates and expensive currency.

Looking out over the week ahead, the economic calendar will not be so bold in jostling the New Zealand dollar. However, the sensitivity the currency has shown to any hint towards the possible future of monetary policy suggests all indicators and unscheduled news will be scanned twice for any influence it may have on Bollard’s perceptions of the economy and inflation. The week will actually begin on a rather strong note with a read on credit card spending for the year through April. In the past, this number would quickly be shirked by traders; but with the RBNZ’s hawkish bias on the line, it may be elevated to the status of retail sales. The credit gauge certainly has its advantages over the more commonly quoted retail figure. For one, Monday’s number is a comparatively leader since it is releasing figures for April. More importantly, it combines a read for consumer spending with a gauge of credit. This gives a more direct indication of how New Zealanders are dealing with current interest rates. If this spending indicator turns, it could be a sign that overall consumption will follow for the same period or a month down the line. The other report that will interest the market for the week is April’s trade balance. The account is expected to have turned to a slight deficit for the month; but the indicator’s real value will be as a gauge for trade’s tolerance of the expensive kiwi.

Boris Schlossberg is a Senior Currency Strategist at FXCM.