US Dollar: Waiting for the Next Big Catalyst, What Could It Be?
As a big proponent of transparency, Federal Reserve Chairman Ben Bernanke had no surprises for the market when he delivered his testimony on the economy and monetary policy to the Senate today. The question and answer session continued to center on the problems in the sub-prime sector and Bernanke responded by reiterating the Fed’s growing concern that the problems in housing could get worse before they get better. He even went so far as to say that sub-prime losses could hit $50-100 billion. This concern is the main reason why the market did not react to the more optimistic minutes from last month’s monetary policy meeting. Bernanke’s take is a far more accurate and current account of how the Fed really feels. Despite a larger drop in leading indicators and a much weaker than expected Philly Fed manufacturing survey, the dollar failed to budge. This was due to the fact that oil prices continued to rise while jobless claims were much lower than expected last week. As long as the labor market holds steady, the economy could still recover. In the near term, the dollar looks prime for a breakout against both the Euro and Japanese Yen. What could cause the next big move? Housing and the Dow. With everyone focusing on the contagion effect of sub-prime problems, next week’s existing and new homes sales will be particularly important. Also, the Dow is struggling to stay above 14,000. If that proves to be unsurpassable resistance, then a reversal in US stocks could also lead to big movements elsewhere in the currency markets.

Carry Trades Still Staying Afloat; Bernanke Focuses on USD/JPY and not EUR/JPY
Yesterday we said that carry traders haven’t given up yet and today that continues to be true. The rebound in the Dow Jones Industrial Average has helped to take AUD/JPY to a fresh 17 year high and keep EUR/JPY, USD/JPY NZD/JPY and CAD/JPY in positive territory. GBP/JPY and CHF/JPY did not join the party, but that was because of weaker economic data. With no major economic data from Japan this week, the US stock market and carry trade correlation has been the primary driver of the strength and weakness in the Yen Crosses. The only piece of data released from Japan was department store sales, which hit a 9 year high. Today, Bernanke helped the rally by defending the Japanese Yen. He indicated that the Bank of Japan has not been manipulating the Yen and for the most part, the weakness of the currency is due to their interest rates and inflation situation. His lack of concern about the currency’s weakness suggests that for the time being, the Yen has not slipped to a level that warrants intervention or even tough words from the US. He is watching USD/JPY and not EUR/JPY. Bernanke harped much more on the issues that the US has with China including their slow pace of currency reform.

British Pound: Weaker Economic Data Puts an End to 4-Day Rally
Weaker than expected retail sales and money supply growth in the month of June put an end to the four day rally in the British pound. After the minutes from the latest Bank of England meeting revealed a less hawkish voting record, traders were just looking for a reason to sell pounds. Yesterday, the price action in the currency pair told us that the new high was driven by dollar weakness and not pound strength. Therefore the consolidation in the US dollar today allowed the British pound to properly respond to not only yesterday’s bearish news, but also today’s weaker economic data. Retail sales grew by only 0.2 percent last month while money supply growth slowed to 13.0 percent from 13.9 percent. These are key inputs into growth and inflation, which means that their disappointment could have a longer lasting impact on the British pound than a one day reversal. GDP is due for release tomorrow and no big surprises are expected there.

Euro Continues to Hover Near Record Highs
The Euro continued to hover near its record highs today. German producer prices were the only piece of data released and they fell short of expectations. Interestingly enough, the Euro rallied on the back of the number. The central bank’s commitment to continue to raise interest rates has helped to keep the Euro steady near its record highs. There were reports today that German Chancellor Merkel is considering introducing measures that would make it more difficult for foreign state controlled funds to invest in German companies. More specifically she is attacking the increasing number of Chinese and Russians that are interested in German companies. This measure of protectionism is a sharp shift away from the comments she made at the Davos conference in the beginning of the year. Back then, she warned of the perils of protectionism and urged greater dialogue between developed and developing nations. Meanwhile over in Switzerland, the Franc broke down after the release of a much weaker than expected Swiss ZEW survey. The trade surplus was higher, but the fact that analysts turned pessimistic on the Swiss economy despite strong economic data was worrisome.

More Gains in Store for the Australian Dollar, Finance Minister Cullen Warns of Interference with RBNZ Policy
The Australian dollar climbed to new highs against the US dollar despite the lack of economic data. Big investors here in the US and in Japan continued to plow into the currency on expectations that the Reserve Bank of Australia may raise interest rates in August. Tonight’s import and export prices will give us a good clue on whether they will actually raise rates. The market is looking for softer inflationary numbers, but any upside surprises will exacerbate the strength of the currency. New Zealand, the country that actually has a rate decision next week consolidated near its 25 year highs. Finance Minister Cullen warned yesterday that he has the power to influence the Reserve Bank’s decision so Kiwi traders should not assume that the currency is a one way bet. Finally Canada released stronger than expected wholesale sales but weaker international securities transactions.

The Australian dollar climbed to new highs against the US dollar despite the lack of economic data. Big investors here in the US and in Japan continued to plow into the currency on expectations that the Reserve Bank of Australia may raise interest rates in August. Tonight’s import and export prices will give us a good clue on whether they will actually raise rates. The market is looking for softer inflationary numbers, but any upside surprises will exacerbate the strength of the currency. New Zealand, the country that actually has a rate decision next week consolidated near its 25 year highs. Finance Minister Cullen warned yesterday that he has the power to influence the Reserve Bank’s decision so Kiwi traders should not assume that the currency is a one way bet. Finally Canada released stronger than expected wholesale sales but weaker international securities transactions.

Kathy Lien is the Chief Currency Strategist at FXCM.