Dollar – Going Nowhere Fast?
Last Friday’s close in the EUR/USD printed at 1.3445. This week after US GDP numbers, Personal Income and Spending reports and the ever popular NFP, the EURUSD ended at 1.3440. Talk about lots of heat and little light. The pair remains stuck in the mud as the economic data from both sides of the Atlantic offers few clear clues to the future forcing the currency markets to muddle along.

The NFP report was a perfect case in point as the headline news appeared to be stronger than forecast printing at 157K vs. 132K consensus, but the number prior was revised downward and the overall figures were tainted by yet another massive addition from the birth/death model which contributed 203K to the overall number. Over the past month the BLS model has added 520K to the headline figures greatly challenging the veracity of those estimates. This is particularly true given the observation from PIMCO that “Detailed data in the Bureau of Labor Statistics (BLS) Business Employment Dynamics (BED) release, which comes out with a two-quarter lag, show employment growth of only 19 thousand in 2006Q3, while the nonfarm payroll tally for that quarter was over 450 thousand. More recently, the BLS’s more timely Job Opening and Labor Turnover Survey (JOLTS) for April – last month! – showed job openings rose only 24 thousand, with this series essentially flat since last August. The JOLTS report also showed that new hires in March (this data subset is released with a one month lag) fell 29 thousand.” However, the questions about the NFP’s weren’t the sole issue for the dollar. On Friday the market also learned that personal income growth dropped to -0.1% - its lowest level in 18 months - while personal spending increased by 0.4%. The -0.5% spread hasn’t been that negative since last May and raised concerns that the US consumer is quickly running out of cashflow.

Nevertheless the problematic state of the US economy is unlikely to severely sabotage the greenback, as growth while moderate remains positive. Next week the US calendar is light with only the ISM and Trade data on the docket. The ISM Services survey could surprise the upside given the stringer reading in ISM Manufacturing and could provide a small boost for the dollar, but in general the price action is likely to be driven by other factors than the event risk of the US calendar.

Euro Strength Contingent Upon Trichet’s Commentary
Euro price action provided little in the way of excitement this week, as EURUSD held between 1.34 – 1.35. Economic data on hand was supportive of the currency, with consumer confidence, retail sales, and manufacturing sector performance all improving. Meanwhile, CPI estimates held aloft at 1.9 percent while GDP for the first quarter gained a healthy 0.6 percent. The question is: will it be enough for the European Central Bank to remain hawkish? The central bank considers inflation of 2.0 percent to be their ceiling, and economic expansion has actually slowed in the Euro-zone, so it is quite possibly that any policy action beyond 4.00 percent will not come.

This week, Euro traders will focus on one event only: the European Central Bank monetary policy decision. A hike to 4.00 percent is widely expected and already priced in, but the key factor to look for is whether ECB President Jean-Claude Trichet continues to use the term “strong vigilance” or uses any other terminology to signal additional policy tightening later in the year. However, there is some risk that he will indicate that the current tightening cycle has come to an end, which could prove disastrous for EURUSD bulls. The releases of Euro-zone Services PMI and the German Trade Balance could also spark a bit of price action, but overall market sentiment will be heavily reliant on the ECB, and given the central bank’s outlook for upside risks to inflation, there is a good chance they will continue maintaining vigilance. Nevertheless, without hard signals of a July hike, EURUSD could actually ease down through 1.3400 to target the 100 SMA at 1.3300.

Yen – All Pain No Gain
On Friday we wrote, “Despite the more than 2% decline in Shanghai the yen continued to flounder ahead of the NFP report today, as carry trade pressure saw no signs of abating. Yen bulls started the week on a promising note as employment and spending data showed improvement. However, as the week progressed the economic news from Japan grew more dreary, With labor cash earnings registering their fifth consecutive month of contraction. In short all of the optimism on Monday was stamped out by Friday, with traders coming to the conclusion that rates in Japan will remain stationary for the foreseeable future. Trading in the yen even decoupled from the usual risk aversion dynamics as market participants shrugged off the overnight decline in Chinese stocks.

It’s difficult to say what will bring the bid back into the yen at this point. Certainly Japanese data has been of no help and until and unless global growth slows down to such an extent that market foresees no additional rate hikes from the G-7 universe, the yen appears to be in a free fall. However, that having been said, at 122.00 USD/JPY is approaching grossly overbought territory and with market positioning so heavily skewed towards the carry, the risks to the longs in that trade increase substantially, especially if there is a sudden shift in sentiment regarding the prospects of global growth.”

Next week is relatively light for the Japanese calendar with only Capital Spending and Eco Watchers surveys of any interest to the market. The Japanese data needs to see some sustained good news in order to for the yen to stage any type of meaningful rally. For the time being with global risk appetite unabated and Japanese eco numbers unimpressive yen has few friends. But risk aversion can reappear within moments notice and given the highly unbalanced state of the carry trade we continue to urge caution.

Pound May Ease on Lack of BOE Policy Action
As we said last week, “fundamental risk from the UK will be at a minimum with no first-tier reports on tap. However, with almost every indicator due to ease back, traders could sap some of Cable’s bid tone.” This was exactly the case as the British pound wrapped up last week softer against the US dollar, especially with the data highlighting a single theme: the slowing of the housing sector. First, Nationwide House Prices rose a weaker-than-expected 0.5 percent in May, while Mortgage Approvals fell back more than expected to 107K, signaling that demand may finally be starting to wane amidst mounting borrowing costs and basic decline in affordability. The other releases on hand pointed to resilience in most other sectors, however, with PMI Manufacturing improving and consumer confidence surging higher. Nevertheless, markets have only central bank decisions on their minds, and with a Bank of England meeting scheduled for this week, traders weren’t interested in making any hard GBPUSD bets.

Early this week, we could see much of the same kind of mild GBPUSD price action as markets will be anxiously awaiting Thursday’s BOE rate decision. After the minutes from the most recent policy meeting surprisingly showed that the central bankers had actually discussed raising rates a full 50 basis points. However, the detail that must be considered is the fact that the BOE only took rate 25 basis points higher in order to allow more time to gauge the effects of previous policy tightening on the economy. Thus, there is almost no chance that the BOE will go to 5.75 percent this week, and perhaps not even in July. We believe that the Bank will want to see how CPI fares over the next few months and will go on to hike in August, barring a sharp drop in inflation pressures. As a result, GBPUSD could return lower to test 1.9750.

Can USD/CHF Resist 1.2300?
The Swiss franc ended the week almost completely unchanged as USDCHF held in a 100 point range despite the release of stronger-than-expected GDP. Economic expansion in the first quarter surged 0.8 percent, bringing the annual rate of growth up to 2.4 percent. Meanwhile, inflation figures were relatively tepid, with CPI up a mild 0.2 percent. Regardless of the soft price pressures, the Swiss National Bank looks primed to continue normalizing interest rates for the seventh consecutive meeting, as the bank fears that expansion will fuel inflation later in the year. However, given the fairly low level of current interest rates relative to the rest of the industrialized nations, there is only so much rate hikes will be able to do for the Swiss franc.

Event risk out of Switzerland will be inordinately thin this week with only the Unemployment Rate scheduled to be released. Nevertheless, the reading could bring about a bit of volatility as the labor market is anticipated to tighten even further. Continued improvements in employment conditions have been a major contributor to consumption and domestic demand growth, keeping the economy on track to maintain the Swiss National Bank’s expansion expectations of 2.0 percent this year. Furthermore, an encouraging Unemployment Rate will ramp up expectations for a hike by the SNB on June 14th and could support a bid tone for the Swiss franc – at least immediately after the release. Furthermore, with heavy Fibonacci and 200 SMA resistance sitting just above 1.2300, any USDCHF gains could be limited as the pair looks to target 1.2230.

Canadian Dollar Shows Few Signs of Slowing
“Another week another Canadian dollar high” has become a bit repetitive, but it is of course an accurate description of Loonie gains. The USDCAD tore through all plausible support levels on its way to fresh 30-year lows, showing little indication that it will slow its incredible descent. Tuesday’s Bank of Canada interest rate decision was the main culprit for the sharp price move; though the central bank left interest rates unchanged, it gave clear indication that it would likely raise borrowing costs through upcoming meetings. Given that the bank explicitly targets an inflation rate of 2.0 percent, a recent BoC Core reading of 2.5 percent leaves monetary policy officials with little choice but to reign in excessive price growth. The developments left fixed income markets in disarray; benchmark 2-year bond yields are now at their highest since 2002. Likewise significant, interest rate futures show that traders now expect the central lending rate to reach a minimum of 4.75 percent through year-end 2007. To put this into perspective, the short-term US-Canada yield spread is expected to shrink from a current 100 to 40 basis points through December. One has to wonder whether the currency may continue such impressive gains on rate expectations alone, but an unabated stream of CAD-positive data could only boost the Loonie further on the coming week’s key reports.

A mid-week Ivey PMI report represents the first of many market-moving events, with an empty Monday-Tuesday ledger leaving scope for an early USDCAD rebound. Canadian dollar bulls hope that the PMI number will show robust growth potential in domestic industry; high consensus forecasts at 64.0 show that markets fully expect such a result. A lack of a noteworthy surprise will leave traders in great anticipation of a packed Friday calendar. The all-important Canadian Net Change in Employment data will clearly guide short-term price action across all CAD pairs. Labor markets have proven incredibly buoyant through 2007, and there is ample reason to believe that last month’s loss in jobs was a small correction before employers add more workers to their ranks. Expectations are similarly upbeat on the later-morning Housing Starts Survey data; strong signs of consumption across the board will likely lead new housing constructions higher on the month. Last but not least, Friday’s Trade Balance figures often bring ample volatility on surprises in either direction. Each of the three key end-of-week economic releases are market-moving onto themselves. Needless to say, the combination of the three provides ample reason to push the Canadian dollar sharply higher or lower across all major counterparts.

Aussie Defies Weak Data to Reverse Declines
The Australian Dollar rallied for the first week in three, with weaker-than-forecast Retail Sales and Trade Balance numbers failing to restrain strong rallies. Robust speculative interest reportedly brought Aussie bids through mid-week price action, with an earlier equity market tumble leaving few lasting effects on the AU$. It is difficult to confirm that speculative interest has indeed rebounded for the Asia-Pacific currency, however; Tuesday’s CFTC Commitment of Traders report showed that net non-commercial longs actually fell by nearly 8k contracts from last week’s levels. We will almost definitely see an improvement in positioning in next week’s report, but whether this turns into a sustained AUDUSD rally will very much depend on upcoming news events. A number of top-tier reports promise great volatility for the Australian dollar through coming days of trade.

Tuesday’s Current Account report will be the first in a string of market-moving releases, with the next day’s RBA Cash Target Announcement and Gross Domestic Product figures to potentially change the direction of current AUD price action. Economists expect that the nation’s large Current Account deficit fell on an improving trade balance, but a disappointment could easily lead to an AUD tumble. Of course, the results of Tuesday’s economic releases will have little net effect if the following day’s reports surprise in either direction. The Reserve Bank of Australia is unlikely to change rates at its upcoming announcement and will produce no commentary on the decision. Though economic indicators have shown strength across the board, low inflationary readings leave the bank in the privileged position of overseeing sustainable economic expansion. The extent to which the economy is expanding will be reported in the same-days GDP data. Economists predict that Australia grew at a 2.9 percent year-over-year rate through Q1, 2007; needless to say, surprises to the downside could undermine a key source of AUD support. Last but definitely not least, Thursday’s employment data promises Aussie volatility regardless of the outcome. The previous month’s incredible 49.6k additional new jobs may lead to a small correction through the recent print. Yet economists predict that the economy added a likewise robust 11.3k jobs through May—leaving risks arguably to the downside ahead of the report.

New Zealand Dollar Rallies With RBNZ On Deck
Though the commodity currencies were making impressive moves against the US dollar across the board, the New Zealand dollar’s massive 2.6 percent, 180-point rally was far and away the best performance of the week. Looking back over the past week’s calendar, it was hard to determine the fundamental source of such a move. Economic data out of New Zealand began to cross the wires mid-week and to little fanfare. Though it was a direct measure for housing sector health - one of two markets RBNZ Governor Alan Bollard vowed must cool before he steps back from his hawkish path - the modest pick up in April’s building permits number was hardly a guarantee for another rate hike. Neither was the M3 number released a little later. The basic inflation report corrected the recent slowdown in its annual figure but was at a mere four month high. By Thursday, the data turned from mediocre to downright concerning. NBNZ’s proprietary business confidence reading for May plunged to a 13-month low with a net 48.2 percent of the survey’s respondents reporting worse conditions. So, what was the trigger for such a monster move? Two things: technicals and speculation over this week’s RBNZ rate decision. For the former, a break above a clear trend channel top that began on April 26th removed a serious ceiling.

Speculation surrounding the upcoming Reserve Bank of New Zealand’s monetary policy meeting is more of a conversation for this week. The rate decision will be almost completely unchallenged by any other fundamental currents. Trying to understand the psychology of those making their bets ahead of the meeting, there are two major groups of people in the market. One faction, perhaps the smaller one, is made up of those expecting another 25 basis point rate hike to a record 8.00 percent. A year ago, the thought of an 8 percent overnight lending rate would have been brushed off by the markets. However, given Governor Bollard’s consistent hawkishness lately, expectations of another quarter point boost to the OCR so close to the April 27th hike don’t seem so far fetched. Indicators have yet to confirm that past policy tightening has cooled the consumer’s hot hand. However, with the lag in data, it would be hasty to assume there has been no effect. This is where economists are coming from. Though many of the same analysts were stung by the RBNZ’s last hike, their confidence that a pass is this month’s result has grown considerably. This is supported by short-term interest rates linked to futures which are showing less than a 25 percent chance of a increase on Wednesday. Given the staggering move in NZDUSD, a pass (or more effectively, any sign of dovish sentiment) could hammer the kiwi lower and temporarily upset the delicate carry trade balance.

Boris Schlossberg is a Senior Currency Strategist at FXCM.