Dollar Caught in the Crosscurrents of Data
Were it not for a final burst of price action in the waning hours of Friday afternoon, the dollar would have been up against the euro for the seventh week in a row rallying 300 points since the lows set at the end of April. However, the stealth rally has been so slow and steady that it was almost difficult to notice. The greenback’s gains are not doubt due in large to the improvement of the US data over the past several weeks as well as the upward creep in inflation gauges. PPI skyrocketed by 0.9% vs. 0.3% expected and CPI also registered its biggest headline gains since August 2005, but the market chose to focus on the slightly softer core CPI reading which dipped to 0.1% from 0.2% expected.

Yet in the end market sentiment remains divided between the bulls who argue that the worst of the Q1 slowdown is over, that growth is picking up and that inflation remains a serious threat and the bears who claim that the tick up in commodity prices is temporary and that housing continues to cast a large shadow over the US economy depressing everything in sight. Friday’s U of M numbers which slid 88.3 to 83.7 gave the last round to the bears, but its far from clear if they have won the match. For now we continue to be range bound and next week’s light calendar is unlikely to resolve the debate unless hosing prints worse than expected.

Will Softer Sentiment Keep Euro Sub-1.3400?
With a complete and utter lack of market-moving data out of the Euro-zone last week, EURUSD closed out Friday almost completely unchanged. With the annual rate of CPI growth still holding at 1.9 percent – just below the European Central Bank’s ceiling of 2.0 percent – the monetary policy committee will likely maintain their stance that rates are still “accommodative.” However, with first quarter labor costs softer than expected at 2.2 percent, traders may perceive the central bank’s fear that wage growth will lead to an up tick in inflation as being unwarranted. Until markets see strong gains in price pressures, they may not be ambitious in pricing in another ECB hike, which creates major downside potential for EURUSD. Nevertheless, as many traders are aware of, all it takes to get a solid rally going for the pair is a bit of hawkish commentary by ECB President Jean-Claude Trichet.

Event risk out of the Euro-zone is filled with sentiment reports this week, as the ZEW and IFO surveys will both released. Sentiment is anticipated to reflect optimism amongst investors, as equity markets continue to reach new highs and businesses throughout the Euro-zone outperform, though the IFO is forecasted to ease back slightly. Not to be forgotten, manufacturing PMI and industrial new orders are both predicted to falter, as export demand could feel the effect of the appreciation of the euro. From a technical perspective, given the fact the EURUSD managed to hold above six month ascending trendline at the all-important 1.3300 level, the pair could be in for further gains if 1.3400 gets taken out, and resilient sentiment could be the fundamental trigger.

Yen Crumbles As BOJ Fumbles
Surprising no one, BOJ kept the overnight lending rate at 0.50% on Friday night. However, it was Governor Fukui’s reluctance to commit to a rate hike in August that hurt the yen pushing USDJPY to a new 5 year high as it sprinted towards 123.50. “We need to be more confident about the outlook for the economy and prices,'' Mr. Fukui said in the post announcement press conference noting that board members were “in absolute agreement that there are still many factors that need to be examined closely.” Governor Fukui’s hesitation on tightening monetary policy even in light of the fact that Japan’s spending on services increased to a six month high, suggests that Japanese policy makers continue to be concerned about the health of consumer demand in the nation and will likely need to see several more months of positive spending figures before committing to additional rate increases.

Fukui commentary of course sparked fresh buying in USD/JPY from carry traders as it essentially assured yield seekers that the interest rate differential between the dollar and the yen will not compress anytime soon. For the time being current economic conditions remain favorable to the carry and despite the fact that yen is woefully oversold it may lose more ground against the greenback unless higher bond yields trigger a massive sell off in US equities in which case risk aversion would most likely trump any yield considerations and USD/JPY would fall.

Next week the Japanese calendar is extremely light with only the All Industry index an event of note and it looks like US yields will continue to be driver of trade in the pair.

British Pound Ascent Could Break Down On BOE Minutes
As we said last 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.” We did in fact see a bounce up to this level, but it had more to do with some jawboning by Bank of England Governor Mervyn King. During a speech given in Wales prior to the CPI report, Governor King said that the BOE “may need to take further action” on inflation as expectations have “drifted up,” which ramped up speculation for a hot release. While CPI disappointed British pound bulls at 2.5 percent annualized (down from 2.8 percent) and initially led GBPUSD lower, the sentiment of King’s commentary held strong, especially as interest rate differentials work in favor of Sterling and will likely continue to do so throughout the year as the Fed is widely expected to stay on hold.

With the exception of the Bank of England minutes on Wednesday, the British pound faces very mild event risk over the course of the week. The danger in the release of the minutes lies in how the central bankers voted in the most recent meeting, as just a few votes for a rate hike in June could lead to speculation of policy action in July. But first, the Rightmove house price index announcement on Sunday night isn’t likely to spark much volatility, as it will likely show much of the same information that we’ve already seen over the past two months – price growth is slowing, but still remains very elevated. Finally, on Thursday, the CBI industrial trends survey should continue to reflect confidence amongst manufacturers, but the price expectations component will likely be the factor to drive GBPUSD reaction. With the pair still holding above trendline support, technicals favor further upside. However, given the thin amount of economic releases due out, GBPUSD could be relegated to range trade between 1.9650 – 1.9800.

Swissie Gets no Help From SNB
The Swiss National Bank raised rates by 25bp to a target rate of 2.50% but the news was a disappointment to traders looking for a 50bp bump and a more hawkish message from the post announcement statement. Despite enjoying some of the best economic fundamentals in the industrialized world, Switzerland has seen its currency depreciate materially against the euro over the past 12 months due to massive carry trades against the unit. The franc, which carries the second lowest interest rate amongst the majors, has been a popular alternative to the yen as a funding currency for the carry trade. Thus, Swiss monetary authorities have been faced with a paradox of facing strong economic growth and a weakening currency at the same time.

Nevertheless, the SNB is not prone to dramatic gestures. Therefore, Swiss monetary authorities opted for the much anticipated 25bp increase rather than the more substantial 50bp hike which would have compressed the interest rate differential between the franc and the euro rather than simply keep it the same. Perhaps one reason that the Swiss policymakers chose the slow and steady approach is the fact that Swiss inflation rate has remained relatively tame. The reading for May registered only a 0.5% year over year growth allaying fears that the weaker franc is importing inflation into the economy. Despite the disappointment, inflation data will continue to be the focus of the market. Therefore next week’s Producer and Import prices will be key to Swiss trade. If the data prints hotter than expected, the franc could get a boost as markets once again readjust their expectations.

How Far Can The Canadian Dollar Retrace Gains?
The Canadian Dollar finished lower for the first week in five, with the currency’s heavily extended rally showing signs of slowing. Though medium-term prospects continue to be bullish for the Loonie, we believe that a short-term correction is overdue. Futures positioning data shows that speculators are heavily net-long the currency—a sign that the bulk of the medium term move is now over. Though this does not preclude further appreciation through the coming months, USDCAD technicals show that a bounce to 1.0800 may occur before possible declines. (For more on our technical perspective, see here) From a fundamental perspective, the week’s second-tier economic reports provided little reason to buy the C$ against its US namesake. This may all change through the upcoming days of trade, however, as the highly market-moving Consumer Price Index and Retail Sales data are sure to spark sharp moves in the currency.

The clear highlight of the week will come on Tuesday’s consumer inflation data, with any strong surprises to potentially change the market’s outlook on the future of Canadian interest rates. Central bank governor David Dodge has plainly said that the BoC may raise target interest rates through the coming months, with economists and futures traders predicting a near-certain quarter percentage point move in July. Given core inflation of 2.5 percent, the inflation-targeting Bank of Canada has little choice but to reign in excessive price growth. Yet synthetic interest rates currently show year-end rates nearly 75 basis points above the current 4.25 percent. This has undoubtedly been one of the major factors behind the Loonie’s impressive appreciation, but such forecasts may prove optimistic if core CPI does not continue higher through the same period. We will watch Tuesday’s data with a very watchful eye—key surprises may set the tone for subsequent days of trade.

Other notable event risk will include Thursday’s Retail Sales report. As in the past, the preceding day’s Wholesale Sales data will likely prove an accurate predictor of surprises in the consumer-linked measure. Both numbers should surprise to the topside if the Loonie is to appreciate—leaving risks to the downside on strong disappointments. Otherwise, the Canadian currency will move on developments in commodity prices. Year-to-date studies show that the C$ is slowly rebuilding its strong correlation to oil prices; continued rallies in energy will likely lend a bid to the currency through the medium term.

Aussie Highs In Jeopardy If Carry Sentiment Doesn’t Hold Up
Like the other economic calendars across the globe, the Australian docket will empty out over the coming days. Looking back over the past week, there were a number of notable indicators, though all were second tier and had little impact on the currency. However, ignoring the reports’ economic class for a moment, the data offered a good overview of the economy with a look into employment, business and consumer sentiment and housing. Taking it chronologically, the Australian Manpower Survey started things off with a third quarter forecast that pulled back to a net 24 percent positive read from 31 percent the previous quarter. A realized pull back in employment from 33-year highs would be a welcome relief by the RBA; though it would certainly cull rate expectations among inflation hawks. Also out the same day was the NAB business confidence survey for May which matched the January 2005 high and boosted expectations of the sector’s contribution to growth over the coming months. Changing focus at the middle of the week, the calendar moved on to consumer-based indicators. The Westpac’s confidence report for June was off a modest 2.0 percent - though at 121.5, the gauge is just below record highs. The last noteworthy indicator on the docket was the lagging HIA new home sales report. Purchases rebounded a hefty 7.1 percent to hit a fresh one-year high. Whether or not this is a sign that consumers are tolerating current lending rates may not be confirmed until another round of spending numbers crosses the wires.

For the week ahead, there are few reports scheduled for release, and even fewer that have ever proven themselves market moving in the past. The single indicator of interest in the data trickle is Tuesday evening’s first quarter dwelling starts. There is no official consensus available for the number which may help to boost its appeal among event traders. Setting up the release, the housing sector has not been one of the stand out sectors in GDP, though it is often times a good barometer for consumer strength and their tolerance for lending rates. Looking outside of the fixed boarders of the docket, carry trade sentiment will likely act as the rudder for the Australian dollar. Last week, RBA Governor Glenn Stevens diffused speculation for a rate hike anytime this year. The highlight from the central banker’s speech a comment that policy makers would have ‘time’ to respond to data on growth and inflation. He went on to say that the latest CPI report showed a ‘welcome trend’ (referring to the quarterly CPI’s drop back within the 1-3 percent target band), though inflation concerns are still significant. This leaves the Aussie dollar in perfect alignment with the growing caution in the overall carry trade. The favored high-yield carry currencies have taken blows in their rate outlooks in the form of plateauing data and policy actions. On the other side of the equation, the SNB just hiked rates with a clear warning of more to follow. Now the health of the popular and prevalent strategy truly relies on the direction and volatility of the representative currencies of the carry trade – the kiwi and yen.

RBNZ Intervention Leaves the Kiwi in a Daze
The Reserve Bank of New Zealand stole market headlines as it intervened in forex markets for the first time since it free-floated the NZ dollar in 1982. The move was enough to force the largest single-day NZDUSD decline in nine months, but a later-week rally showed that markets are not yet prepared to yield to official selling pressures. The bank is rumored to have sold its own currency at multi-decade highs of 0.7636, then again near the 0.7560 mark. This left the currency consistently lower through the week, with later Retail Sales data likewise leading to Kiwi declines. Yet bulls remained out in full force as the currency halved its earlier tumble, remaining dangerously close to 0.7560. A virtually empty calendar through the coming days of trade leaves emphasis almost solely on the domestic central bank.

It seems increasingly likely that the RBNZ will once again intervene by selling its domestic currency, but it remains anyone’s guess as to whether this will be effective in halting the currency’s longer-term advance. According to official statistics, the Bank holds approximately NZ$10 billion in foreign currency reserves. Some dependable sources speculate that the bank may risk to lose as much as NZ$1 Billion in its intervention, leaving it considerable wiggle-room in achieving its goal. Yet all of the official selling pressure imaginable will amount to little if markets do not believe such sales will force a medium-term turn. Truly authoritative estimates are difficult to come by, but one can likely assume that overall carry trade interest far outweighs the central authority’s selling clout. Speculative Kiwi futures net-longs, as reported by the CFTC, amount to approximately NZ$2.6 billion. On the surface, such extended Kiwi positioning is bullish; markets clearly expect the currency to head higher despite official sales. Yet such one-sided wagers may eventually be the NZD’s undoing—the unwind of heavily net-long bets may force a medium-term turn in forex markets. This may not preclude a short-term Kiwi rally, but it seems increasingly likely that the weight of RBNZ selling and risks of carry trade unwind will produce the end of the Asia-Pacific currency’s gains.

Boris Schlossberg is a Senior Currency Strategist at FXCM.