Buck Burned By Big Ben
At the start of the week the EURUSD showed all the signs of consolidation and the dollar even started a mild rally as the pair broke below the 1.3800 barrier. But Ben Bernanke’ s testimony on Wednesday and Thursday stopped all dollar bullish sentiment dead in its tracks as the Fed chairman painted an ominous economic landscape facing the country. As we noted on Thursday, “Dr. Bernanke’s candid comments regarding the state of the US housing sector (which he noted continued to slow due to lack of demand and more stringent credit criteria) knocked dollar bulls for a loop as it suggested the risk of further contraction for the US economy. Although the chairman reaffirmed his hawkish bias, in effect telegraphing to the market that short term rates were unlikely to be cut anytime soon, the Fed did lower its 2008 GDP forecast by 25bp from 2.75%-3.00% to 2.50%-2.75% range and that may have been the key factor in triggering a new round of dollar liquidation.”

Next week housing data may determine whether we test the 1.400 barrier or recede back from the highs. The sub-prime fiasco continues to weigh heavily in the background as traders fear additional bankruptcies in the sector. Yet another round of weaker than expected data would only exacerbate those fears and could push the EURUSD to 1.3900 and beyond. On the other hand with forecasts already low if the housing sector could demonstrate some stabilization, the greenback may get a boost especially if Durable Goods and GDP data show signs of a rebound. In short while dollar longs look to be on the edge of collapse, the drive to 1.40 is not a foregone conclusion.

Euro Primed To Breakout – Will It Target 1.40 Or 1.37?
Range trades prevailed for many currency pairs last week, but the pattern was especially noticeable in the EUR/USD, as price teetered around the 1.3800 level before hitting a fresh record of 1.3842 on Friday morning. European economic data didn’t necessarily warrant a strong bid tone for the euro, as consumer price growth slowed last month from 0.2 percent to 0.1 percent, leaving the annualized rate below the central bank’s 2 percent target for the tenth consecutive month at 1.9 percent. Meanwhile, the ZEW survey surprisingly fell in July, as the consistently hawkish rhetoric of the European Central Bank leaves investors worried about how much higher interest rates in the region can actually go. However, we have seen central bankers start to quiet down recently, as calls that rates remain “accommodative” and comments that inflation risks remain to the upside come far less frequently.

As the ECB’s hawkish stance slowly starts to fade, it appears that gains for the Euro are harder and harder to come by, however, that doesn’t necessarily mean that EUR/USD bulls are out of the game yet. Mixed economic data could set the stage for continued range trading, but given the tight consolidations we’ve seen as of late, traders are looking for either a breakout to 1.40 or a dip back down to 1.37. While this will likely have more to do with a shift in US dollar sentiment, event risk out of the Euro-zone could play a role as well. First, conditions in the manufacturing and services sector are anticipated to remain resilient, with PMI results still well above the 50 boom/bust level. Aside from the headline, though, traders should key into price and employment components, as they could signal changes in broader trends. Meanwhile, investor and consumer sentiment are predicted to diverge, with IFO expected to fall back amidst higher interest rates and the GfK survey predicted to reflect optimism as labor markets tighten and economic expansion remains resilient. Nevertheless, with resistance looming above at 1.3832, a EUR/USD turn lower may be in the cards this week.

Japanese Yen Still Ruled By Risk Aversion
For the second week in a row, gains for the Japanese yen were initiated by bout of risk aversion, with the biggest moves coming on Friday. The combination of news that the S&P cut credit ratings on 14 European synthetic CDO tranches along with a plummet in US equity indices took USD/JPY out swiftly. In fact, the pair fell over 100 points in just a few hours to test the 121.00 level, and with interest rates in Japan still at an ultra-low 0.50 percent, the price action signals that a hike by the Bank of Japan may not necessarily be needed in order to initiate a massive unwinding of carry trades and confirming the dangers associated with maintaining highly leveraged trades.

Looking ahead to this week, the Japanese yen is likely to soften as fundamental data is anticipated to highlight the fact that deflation continues to persist. Core Tokyo CPI measures may stay in negative territory, as consumer prices excluding fresh food are estimated to hold at an annualized -0.1 percent, and as long as price growth continues to reflect contraction, the Bank of Japan will have little leeway to normalize interest rates. Boding slightly better for the yen, consumption growth is predicted to show a further recovery from last year’s feeble state, as retail sales are estimated to rise 0.6 percent, while the trade surplus is expected to widen despite a slowdown in US demand for Japanese products. Nevertheless, risk aversion trends continue to have the greatest hold over Japanese yen trading, and with Elliot wave trends signaling a rebound for USD/JPY, the pair could recover back towards 122.50 this week.

British Pound’s Highs Come Into Focus As Calendar Clears
Another week, another high for GBPUSD. Last week, the pair touched a new 26-year high amid a slew of economic indicators that were largely mixed. Looking at the long list of data points that crossed the wires over the period, it was clear that there were a number of themes that were covered. Taking it chronologically, inflation started traders off. Tuesday morning brought the release of the CPI and RPI numbers for June. Only a few months ago, these indicators had forced BoE Governor Mervyn King to right a letter to then Chancellor of the Exchequer Gordon Brown and explain what will be down to bring them back in line with the central bank’s tolerance band. Ultimately, this meant a rate hike. How things have changed in only a few months. The annual headline version of the CPI report decelerated to a 2.4 percent pace, the slowest in over a year. Moving along, the consumer sector found data that was a little more mixed. Jobless claims through the month of June fell for a ninth consecutive month – bringing the unemployment rate to a two-year low. However, any bullish sentiment this may have won in the market was swiftly offset by a substantial deceleration in earnings for May. At 3.5 percent, year-over-year earnings growth was at multi-year lows. The bearish sentiment was only exacerbated by a miss from retail sales for June reported the following day. In the end though, the pound’s high perch was salvaged by a strong growth report. The advance measurement of second quarter GDP curbed expectations of second consecutive deceleration by printing a repeat 3.0 percent annual pace.

Looking ahead to the week ahead of us, the pound will not likely be making any big moves based on the ebb and flow of the economic calendar. There are only a few numbers penciled in for release over the coming days. Both the Rightmove and Nationwide housing price indices for July have garnered some attention in the past, though it has not been much since analysts have already pegged the housing sector as a steady contributor for the bulls. Barring any significant drops from these reports, the pound will not likely make many waves in post-release trade. The same can be said for the CBI Industrial Trends Survey for July. So what could move GBPUSD next week? From the UK specifically, rate speculation surrounding the BoE could take the helm. Last week, the minutes to the last BoE meetings showed a 6-3 vote ushered in the last 25 basis point hike – not the screamingly hawkish count that would indicate follow through to the next gathering. What’s more, GBPUSD could tumble (taking the rest of the pound crosses with it) should the dollar stage a come back. With a number of big US report’s on the docket (including a 2Q GDP report) the greenback will have its shot at a recovery.

Swissie Undercut By Inflation Data
The week started off strong for Swissie bulls as Retail Sales jumped a very strong 7.2% indicating the healthy consumer demand led by ever tightening labor market. The fact that Switzerland enjoys one of the strongest economies in G10 is no secret, however the franc has been persistently hobbled by it slow interest rates weakening to record lows against the euro. Those rates are dictated in large part by Swiss inflation data and on that front tSwissie longs saw no help this week. As we wrote on Friday, “One other surprising release of the night came from Switzerland which saw Producer and Import Prices dip unexpectedly to 2.8% yearly pace from 3.2% expected...the decline was a bit of a shock given the weak franc and higher energy costs during the period. Inflation remains the key variable in determining SNB’s monetary policy for the rest of the year. The primary question facing the market is whether the Swiss central bank will ratchet rates by 50bp at the next meeting with the possibility of 75bp of total tightening by the end of the year or whether it will opt for the consensus view of incremental 25bp hikes in both September and December.. However, with buoyant consumer demand, tight labor markets and EURCHF cross once again approaching yearly highs at 1.6673, the SNB may choose the ignore the price data and make a pre-emptive move to stem the slide in the franc. Mr. Roth and company have already warned the markets when the cross reached these levels last month. This time they may opt for more substantive policy than mere verbal intervention. Indeed with ECB now rather guarded about the prospects of a September rate hike, and the SNB increasingly uncomfortable with the weakness of the franc, the market may be overestimating the chances of further policy action from the EZ and under pricing the possibility of a more aggressive move from Switzerland. “

One key factor swaying the SNB may be this week’s KOF reading. Should the LEI gauge print above the psychologically important 2.00 level for the first time this year, the banker in Zurich may be compelled to act.

Canadian Inflation Dips, Does Loonie Have Further Room To Go?
The Canadian dollar continued to plow through multi-decade highs on the week, reaching peaks of C$1.0399 before consolidating through later trade. Price action was relatively tame for the Loonie, but a continued US dollar tumble was the primary driver behind the USDCAD’s fresh lows. Indeed, the Canadian currency slipped against most foreign counterparts on a mild disappointment in Consumer Price Index figures. The Core inflation rate rose less than expected at 2.5 percent on a year-over-year basis from 2.2 previous. The net 0.3 percentage point rise over May’s figures was entirely due to softer base effects, as the month-over-month inflation rate came in exactly flat. Traders took the opportunity to unload overextended Loonie longs, with the USDCAD 50 points higher in the moments that followed. Yet the move saw little extension through the rest of the day’s trade; bulls were quick to re-establish USDCAD shorts on an uneventful US CPI report. Later data was limited to second-tier Wholesale Sales and International Securities Transaction reports. The former came in marginally above consensus forecasts and did little to move markets, while the latter showed that net foreign purchases of Canadian securities unexpectedly dropped by C$3.111B in May. Looking at the individual components, such a tumble came largely on new bond retirements and hardly signaled a shift in investors’ appetite for domestic assets. As such, the report had little effect on the Loonie through end-of-day price action.

The coming week will see relatively little event risk for the world’s eighth largest economy, with a mid-week Retail Sales report the sole top-tier release on the ledger. A positive print in this past week’s Wholesale Sales data bodes well for the outlook on the consumer spending, with analysts already predicting a 0.6 percent gain on a month-over-month basis. The Loonie may regardless show difficulty continuing its assault on its US namesake in what will likely be a week of consolidation. Fresh lows on the USDCAD suggests that futures positioning remains incredibly one-sided on the pair, which typically signals that a reversal is near. We will refrain from calling a bottom on the pair, but a break above 1.0500 may eye continued extension to the topside through the short-term.

Australian Dollar Performance Hinges on CPI Report
The Australian dollar rallied for the eighth week in succession, working its way to fresh 18-year highs against its downtrodden US namesake. Such rallies came on little in the way of economic data, as a second-tier Westpac Leading Index report did little to move markets. Instead it seemed that the carry trade remained alive and well—evidenced by the gains in the DailyFX carry trade basket. Such a dynamic took a hit through mid-day Friday trade; a swift US equity sell-off led to a similarly pronounced drop across all high-yielding currencies. Though its effects on the AUDUSD were comparatively limited, the Australian Dollar-Japanese Yen cross fell an incredible 100 points in a mere hour of trading. Later price action saw the pair level off and consolidate through the rest of the day, but markets nonetheless showed hesitation to plow back into profitable JPY shorts. Whether or not such renewed risk aversion will continue through the coming week of trade remains a key question for the Aussie, with significant event risk to likewise drive volatility across AUD pairs.

The clear highlight in the coming week’s calendar will come on Tuesday’s Consumer Price Index data. Markets expect the key inflation figure to come in at a robust 1.0 on a quarter-over-quarter basis, while the yearly rate is expected to drop to much more moderate 1.9 percent. Such a slowdown in year-over-year price growth is clearly the result of strong base effects, however, and will mean little to the inflation-targeting Reserve Bank of Australia. The central bank’s stated comfort zone is yearly inflation within a 2-3 percent range. Going by this alone, we could expect a sub-2.0 result to ease the bank’s hawkish stance on overall price developments. Of course, some quick calculations will show that a 1.0 percent QoQ gain is the equivalent of approximately 4.1 percent in annualized terms. Surprises in either direction could easily shift interest rate expectations for the Aussie economy and subsequently affect all AUD pairs. Interest rate futures have currently priced in a definite 0.25 percent interest rate increase through year-end, which has undoubtedly boosted the domestic currency against major trading counterparts. Yet negative surprises in the CPI numbers could easily undo such speculative AUD longs and cause immediate sell-offs. Whether or not the Aussie may continue to gain may hinge upon such data—almost a guarantee of volatility in the moments to follow the report.

Market Readies For Another RBNZ Hike Just As Cullen Pipes In
The market keeps raising their stakes on the New Zealand dollar. This past week, the currency rallied to a new 25-year high against its US counterpart while putting in for a new record against the Japanese yen. And while traders blindly bid the unit to new highs, the fundamental engine behind the move continued to sputter. The economic calendar was relatively light over the previous week; but the indicators that did make the cut were certainly big-name market movers. Of the two noteworthy releases, the lesser indicator was the CreditCard spending report for June. While this indicator has historically been a lower tier report, RBNZ Governor Alan Bollard’s vow to rein in consumer spending bumps it up on the Richter scale. Despite the recent string of rate hikes, spending data has thus far not convincingly reported a serious slow down. The credit indicator printed a 9.1 percent increase in buying appetite in the year through June – a six-month high. Alternatively, inflation – supposedly the key to monetary policy – has leveled out and given doves fuel for the battle against the consistently hawkish governor. While the government reported a 1.0 percent increase in the consumer-basket in the first quarter, the more important annual number hit a three-year low of 2.0 percent. This was slightly better than the 1.8 percent read expected; but overall it is right in the middle of the RBNZ’s self-prescribed 1 to 3 percent tolerance band. At these levels, it becomes hard to see Bollard’s reasoning for future price pressures that necessitate action now.

Now turning to the week ahead, the rate debate will certainly intensify. The docket for the first half of the week has been cleared out to make way for the all-important RBNZ rate decision. The life-blood of the New Zealand dollar, rate speculation is well past the high pressure mark. Already coming off three rate hikes issued by Governor Bollard at the last three meetings, both economists and the market are betting on a fourth to bring the overnight cash rate to 8.25 percent. Without a doubt, forecasts for another hike have already played into building up some of the currency’s recent strength; so there will be a lot riding on this next move. Considering this innate bias, a pass could be taken rather badly by speculators. On the other hand, it would hardly mark the end of the line for the kiwi since there is a lot of non-speculative interest backing it up. More important then is the medium-term outlook for policy action; and politicians may be getting in on the debate on this front. Finance Minister Michael Cullen warned journalists and Parliament last week that he has the power to alter the RBNZ’s objectives for monetary policy. So instead of targeting inflation solely, a growth factor can be thrown in and completely change the outlook for interest rates. While Cullen hasn’t threatened to do this just yet, just the mention sends shivers down bulls’ backs.

Boris Schlossberg is a Senior Currency Strategist at FXCM.