Dollar Yields to No One
“A wild night of trade in the currency markets,” we wrote on Friday, ”as dollar was bid across the board after US 10 year yields rose to 5.24% their highest value since July 2006.” Indeed yield was the story of the week as the greenback gained 60 basis points on the euro, 70 on the pound and 50 on the franc. Only the commodity dollars, helped by their own yield stories stood up to the greenback.

The buck also received some help on the economic front, as ISM Services skyrocketed to 59.7 from 55.8 indicating that demand in the largest sector of the US economy remains healthy despite the persistent woes in housing. Finally on Friday, dollar bulls also saw a nice contraction in the Trade Deficit which shrunk to -58.5B from –63.5B initially projected. Ironically enough the buck saw little price action from that news as 10 year yields receded to 5.12% by Friday afternoon proving once again that bonds now control in both equities and FX.

Next week may prove to be more of a challenge for the greenback. The action won’t kick off until Wednesday, when Retail Sales numbers print. Initial indications are that the number may be soft – no surprise given the high cost of gasoline and flat wage growth. If however, the Retail number manages to beat expectations the rest of the week could be very friendly to dollar longs as inflation gauges are likely to run hot and talk will focus on a possible Fed rate hike in price pressures persist.

Euro – No Definite Dates in Sight
On Wednesday we wrote, ‘the marquee event of the day will be Mr. Trichet’s press conference after the expected rate hike to 4% with traders focused on only one question – when will the next hike occur? Typically, Mr. Trichet refuses to assign specific date targets to any future policy moves and we anticipate today to be no different. Although the EZ economy continues to perform well, ECB officials are unlikely to rush their next policy action especially with headline inflation contained at 1.9%. Instead we believe that they will want to digest the impact of the current hike for at least several months before considering any further tightening.” The scenario played out exactly as we expected with Mr. Trichet remaining non-committal as to ECB future plans and the euro quickly ran out of gas. The unit was hurt further by the news that both German Factory Orders and Industrial Production fell far worse than forecast suggesting that the high value of the currency may be finally starting to weigh on the region’s most important sector.

Next week, the EZ calendar carries very little important even risk with just a slew of second tier reports that are unlikely to impact the price action for more than 20 points at a time. The direction of the pair will most certainly be driven by the US events as traders watch bonds, US Retails Sales and inflation reports. For the time being the EURUSD continues to bounce around in a wide range between 1.3650-1.3350 but if the news of the week prove positive for the buck the pair could easily tumble to the lower 1.3000 to test its true supporting that region.

Yen – Carry no Problem?
On Friday Japan’s “Mr. FX” the finance ministry’s top currency official Hiroshi Watanbe brushed off fears of an unwinding of the yen carry trade despite this week’s sharp rise in US bond yields. Mr. Watanabe, vice-finance minister for international affairs, told reporters that he did not think “the yen carry trade has any immediate risk of unwinding adding further that, “The size of any carry trades that would unwind is relatively small compared to the entire foreign-exchange market.” Whether Mr. Watanabe will be correct remains to be seen but for now the carry trade stayed in place and the yen continued to suffer for it. But as we cautioned on Friday, “Although the yen did not suffer as badly as the other major currencies, it did not escape dollar’s wrath. Tonight’s story was clearly all about dollar’s strength rather than simply carry trade liquidation. Nevertheless most of the yen crosses declined as well as the bump in US yields in likely to weigh on US equities which in turn will create new bouts of risk aversion and further unwinds in the carry trade.”

For the time being the yen held its ground raising 20 basis points for the week. Certainly the carry trade appears to be very tired, but Japanese monetary officials are unlikely to expedite the unwind. This week’s calendar brings yet another BOJ rate decision which likely to be an non-event. Even if its followed by hawkish rhetoric the market will most demand proof before believing that BOJ officials are serious about monetary tightening. Thus in the end yen’s fate still appears to be tied to risk aversion rather than any economic developments form Japan.

British Pound Could Make a Comeback on CPI
While most fundamental indicators for the UK last week signaled rosy times for the economy, the announcement that the Bank of England did not want to raise rates led GBPUSD lower. These declines proved to be a slippery slope as an 80 point drop quickly turned into a 260 point slump with GBPUSD ending the week near 1.9650. While the BOE’s decision was widely expected by the markets, there was a bit of risk that the surprise-prone central bank would seek another round of policy tightening. Nevertheless, as we’ve mentioned before, after the minutes from the May meeting showed that the central bankers had actually discussed raising rates a full 50 basis points, it is worth noting that the BOE only took rates 25 basis points higher in order to allow more time to gauge the effects of previous policy tightening. Thus, it made sense that the bank left rates steady in June, and they will likely do so again in July. In fact, 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.

This week, GBPUSD could be in for a bounce based on both technical and fundamental factors. Looking at the daily charts, the pair’s plunge was stopped short at seven month trendline support and the 50.0% fib of 1.9183-2.0131 at 1.9657. Should GBPUSD hold up against support, price could bounce up towards 1.9775 with the help of strong economic data. Inflation reports may only underpin estimates of an August hike as PPI and CPI are both anticipated to remain elevated, while signs of further tightening in the labor market will feed into concerns of mounting wage pressures. Furthermore, Retail Sales are forecasted to rebound as well, signaling that consumption remains healthy despite higher interest rates. However, with BRC Retail Sales for the same month indicating a sharp slowdown, there are major downside risks for this particular release. Nevertheless, should speculation about the BOE’s future policy action remain the dominant theme in British pound trade, GBPUSD gains will likely resume by mid-week.

Swissie May Remain Sour Even With A SNB Hike
Encouraging economic data out of Switzerland was not able to lend the Swiss franc strength last week as technical factors took hold and carried USDCHF 200 points higher to break a critical resistance level. A one year trendline and the 200 SMA did little to slow the USDCHF ascent, and while the price action had more to do with the market-wide US dollar bid tone, Swissie barely stood a chance. Looking at fundamental data, the release of the Swiss Unemployment Rate at 2.7 percent – the best reading since October 2002 – should have bid well for the national currency, especially ahead of the Swiss National Bank’s quarterly policy meeting on June 14th. However, with interest rate differentials still working against Swissie - even with another rate hike to 2.50 percent – the currency will remain susceptible to broad carry trade flows.

As we mentioned, a rate hike by the SNB this week isn’t likely to do much for the Swiss franc in the long-term, as the carry trade will likely continue to work against the currency. However, USDCHF may see a brief, sharp dive towards 1.2312 (trendline resistance and 200 SMA are now support) upon the announcement of rate normalization on Thursday as such policy action is undoubtedly bullish for Swissie. Nevertheless, once market reaction cools down and broader sentiment comes back into play, USDCHF will likely continue its push towards 1.2450.

Will the Canadian Dollar Resume Its Rally?
Has the Canadian dollar rally finally been exhausted? We’re not prepared to call a bottom yet, but 1.0550 held up as solid support for USDCAD last week. Economic data hasn’t necessarily been working in the favor of Loonie either, as Building Permits for the month of April contracted more than expected at a rate of -8.4 percent. However, given the volatile nature of this release (the figure surged 26.5 percent the month prior), market reaction was at a minimum. Meanwhile, Ivey PMI proved lackluster, as the business activity gauge rose to a softer-than-expected 62.7, though by continuing to improve and showing expansion in the sector, the release still underpins a Loonie bid tone. Finally, labor market data was similar to Ivey PMI, in that the release was weaker-than-expected but still showed improvement.

This week will serve as a major test for USDCAD, as thin data flow could leave Loonie to flounder. New Housing Prices are estimated to grow 0.3 percent once again in the month of April, though USDCAD reaction will be mild given the release’s low market-moving status. At the same time, the Capacity Utilization Rate is predicted to edge higher. Thought to be a leading indicator of inflation, the announcement may give Loonie a brief boost – albeit a small one. Nevertheless, regardless of the scheduled releases this week, markets have little reason to sell-off the Canadian dollar considering that oil prices remain lofty, CPI is still above 2.0 percent, and exports are holding up well. All of these factors underpin the case for a hike by the Bank of Canada in July, and with the US Fed likely to remain on hold throughout the year, shifting interest rate differential are slowly working in the favor of Loonie. As a result, markets should remain cautious of trying to capture a turn in USDCAD, as there is little fundamental basis for a full turnaround and the pair could indeed continue to plow down through 1.0550.

Aussie Rallies On Strong Data, A Flood To Carry Trades
Among all the central bank decisions last week, the outcome for the Reserve Bank of Australia’s deliberations was one of the unknowns. Ultimately, the policy group, led by Governor Glenn Stevens, held the overnight cash rate steady at a six-year high 6.25 percent as economists had expected. However, the other indicators filling out the economic calendar may be lying the ground work for another 25 basis point hike sometime in the near future. The overcrowded docket reported economic strength on all fronts. The business sector was proving it was weathering a crimp from wage inflation and a local currency at multi-decade highs. A wrap up on first quarter corporate operating profit reported a booming 7.6 percent increase over the first three months of the year for the best performance since the second quarter of 2005. Insuring that the outlook is just as bright as the past, the Westpac Industrial Survey for the current quarter also rose reflecting the strength of strength in demand and projections that rates are on hold for now. Jumping sectors to the housing market, building approvals for the year through April crossed back into positive territory for a 4.5 percent pick up. A far more impressive improvement though was seen in the employment numbers for May. Firms took on nearly four times as many new workers as economists had forecasted, which in turn cut the employment rate to a 33-year low 4.2 percent. Encompassing all of this data and putting the exclamation point on the rate outlook, first quarter economic growth accelerated to a nearly three-year high 3.8 percent pace.

Looking ahead to this week, the Aussie dollar will look to catch a considerable draft from last week’s whirlwind calendar; though fresh fundamentals will have their influence on the currency. There are only a few second-tier reports on deck, though consistency with last week’s bullish data run could certainly leverage the data’s impact. On Tuesday morning in Australia, the NAB Business Confidence survey will provide an up to date read on corporate sentiment. On the following day, Westpac will release its gauge on consumer optimism, which will no doubt be colored by recent employment and wage numbers – not to mention overall growth conditions. Finally, the fundamentals schedule will wrap up with the HIA New Home Sales Report for April, which will offer a look into how Aussies’ spending habits are really holding up to current interest rates. While macro data will certainly have its place in FX trading next week, the real action may come on trends in risk aversion and carry trade. In the past week, a sell off in global equities sparked an unwinding of risky trades across the board. However, a hike from the RBNZ, reminded currency traders of why they were sticking with the carry. Backed by a sound economy and a 6.25 percent benchmark lending rate, the Aussie dollar will be a leader should the carry gain momentum.

New Zealand Dollar Surges On Hike With Doors Open For Another
There were two events scheduled for release in New Zealand last week, but traders were really only interested in one – the Reserve Bank of New Zealand’s decision on interest rates. The central bank, helmed by Governor Alan Bollard, surprised economists - but not the market according to the interest rate curve prior to the event - when the monetary policy authority lifted the overnight lending rate 25 basis points to a nine-year high 8.00 percent. This is the third increase from Governor Alan Bollard since March, and has only further engrained the New Zealand dollar’s title as the symbolic leader of the carry trade. However, the rate hike itself was not most market-moving aspect of the announcement. What truly stoked the kiwi was Bollard’s unflappable hawkishness. Charged with keeping inflation between 1 and 3 percent, the central bank governor kept the door wide open for further tightening when he said consumer spending and housing demand are fanning inflation to uncomfortably high levels. Interestingly, immediately after lifting the overnight lending rate and opening the flood gates to even more foreign capital, Bollard theorized that the exchange rate is at levels that are “both exceptionally high and unjustified on the basis of New Zealand’s medium-term fundamentals.” Whether this was a weak attempt to talk the currency down or if the central banker is genuinely confused is unclear.

For the week ahead, the New Zealand dollar has already made its technical breaks and is well-equipped to extend its rally as rate expectations offer greater incentive for foreign investors to direct their capital to the island nation and its domestic currency. As it stands, interest rate markets have almost fully priced in another rate hike by the end of the year and there is even a 30 percent chance for a lift to 8.25 percent at the July 26th meeting. Looking at the economic calendar though, rate forecasts could change dramatically as a number of critical indicators are set to weigh in on Bollard’s key trouble areas for persistent inflation. The two headline reads for the week will be the House Prices indicator for May and retail sales report for April. There is no specific time or consensus attached to the housing read, but the spending number is expected to pass the month unchanged. Softer reads from both indicators would certainly open the door to doubt over the necessity of another rate hike. Keep in mind, consumer inflation ran 2.5 percent in the first quarter, well within Bollard’s range. What’s more, the central bank’s own projections see pressures easing to a 2.2 percent pace next year. Another barrier to hawkish speculation may be the ANZ business report and first quarter manufacturing activity, which may reflect the pain a currency at 25 year highs is inflicting.

Boris Schlossberg is a Senior Currency Strategist at FXCM.