US Dollar Hits Fresh Record Low, Will Friday’s US Data Trigger a Turn?
With the US Dollar establishing new record lows against the Euro for the second day in a row, many traders have been left wondering how much lower the greenback can possibly fall. Given the ramped-up speculation regarding the possibilities of a rate cut by the Federal Reserve next Tuesday, targets of 1.40 do not seem out of reach. Nevertheless, with the release of US retail sales anticipated to improve on Friday, the greenback could see a substantial boost. Figures from many retailers for the month of August have already highlighted steady sales during the back-to-school season, despite deteriorating labor markets and a housing recession. However, many retailers have also reported that the sales gains were the result of massive discounting, which cannot go on forever given the practice’s negative impact on profit margins. Regardless, forex traders will likely respond in a somewhat short-sighted manner and take EUR/USD for a tumble, especially if retail sales are better-than-expected and act to quell speculation of a rate cut by the Fed.

Euro Continues to Trade Near Record of 1.3927; SNB Hikes Despite ECB’s Pause
The strength of the Euro prevailed during the early NY trading session today, as the currency reached a record high of 1.3927 against the US Dollar, a 14-month high against the British Pound, and a one month high against the Japanese Yen. Commentary from ECB Governing Council Member Yves Mersch helped propel the currency higher, as the policy maker said that the ECB “may resume tightening” depending on the analysis of new data, which leaves the door wide open for a hike to 4.25 percent before year end. This hawkish bias is especially pertinent as it comes on the tails of recent commentary from ECB President Jean-Claude Trichet, who continues to call monetary policy “accommodative.” The ECB isn’t the only central bank in Europe that continues to consider higher interest rates an option, even in the face of volatility in the financial markets. In fact, the Swiss National Bank raised their 3-month Libor target rate to 2.75 percent this morning, marking the bank’s eighth consecutive quarterly hike. While the SNB’s growth outlook remains optimistic at 2.5 percent for 2007, “greater than usual” uncertainties and an anticipated slowdown in momentum for 2008 signals that the central bank’s rate normalization cycle may come to an end – or at least pause – during Q4.

With the Return of Risk Appetite, Japanese Yen Loses on the Session
It seems that a stronger yen may be dulling the investment appetite of Japanese funds, as per the Ministry of Finance’s report last night. According to the survey, net foreign stock holdings by Japanese funds declined by 43.89 billion, as fixed income investments dipped 95.9 billion yen during the week of September 7. With the underlying currency appreciating as much as 6 percent against higher yielding currencies like the US dollar, investors are beginning to see weakness in the their foreign holdings purporting a return to cash. However, the extreme report reading has also given investors reason to boost their risk appetite once again in the session, helping yen crosses to push higher in the day. Incidentally, the currently positive rally will remain dependant on tomorrow’s assessment of the world’s second largest economy and its industrial productivity. Although policy makers have cited strong manufacturing sector activity and underlying growth, market participants will look to confirm the notion. Unfortunately, for yen bulls, the figure is expected to remain widely consistent with the month’s preliminary reading, with a decline likely to boost yen weakness.

RBNZ Offers No Surprises, Leaves Rates Unchanged
Alongside the decisions of other central bankers including the Reserve Bank of Australia and the Bank of England, the Reserve Bank of New Zealand kept interest rates unchanged at a record high 8.25 percent last night. Citing that a falling currency and rising commodity prices will continue to support higher inflationary pressures, Governor Bollard’s decision stands amidst an evaluation of the extent of the recent US subprime debacle. Noting that there is a “bit of inflation pressure in the system”, Bollard in a statement today noted that central bankers “continue to expect a significant boost to the economy over the next two years.” The increase in growth will support a “sharp rise in world prices,” boosting the likelihood of another round of tightening. However, the notion temporarily fell into questionable territory following the lackluster retail sales data in the month of July. Usually a supportive release for Kiwi enthusiasts, the report showed that consumer spending in its rawest form actually pulled back in the monthly assessment. Printing unchanged for the month, the ex-auto figure declined by 0.2 percent. The release was pessimistic for the economy considering the 0.3 percent advance expected by the investment public. Nonetheless, with the NZD/USD higher, speculators will turn their focus to tonight’s supplementary releases for the week. The manufacturing activity report may helpl boost the notion of further growth (ie rate hikes) with expansionary suggestions.

With No Economic Data, Expectations of Next Week Emerge
Pulling back mildly against the US dollar in the overnight, the British pound rocketed higher during the session as traders look ahead to next week’s round of pertinent releases. The GBP/USD was able to break above the 2.0300 psychological level, from a session bottom of 2.0233. Granted, the overwhelming boost was slightly on the result of GBP/JPY cross action, as the pair jumped over 200 basis points on the day. However, with the cornucopia of reports slated for next week, the market could not dismiss the fact that bidders were out and about in hopes of gaining from supported carry expectations. As a result, momentum looks to continue throughout tomorrow’s session until the weekend close with both consumer prices and the central bank minutes on the mind of the market.

Kathy Lien is the Chief Currency Strategist at FXCM.