Weekly Analysis of the Majors - Dollar: Ready to Rebound?

Talking Points

The US Dollar $ - Dollar: Ready to Rebound?

At the start of trade this week the greenback was caught against the ropes and looked like it was ready to collapse as the panic over the GSE bailout pushed EURUSD to all time highs at 1.6040. But no sooner had the pair reached that lofty level than the hysteria receded as Wells Fargo reported better than expected numbers, oil dropped by more than $15/bbl and capital markets were pacified for the time being about credit worthiness of GSE debt.

In short a slew of positive macro factors cushioned the greenback's decline and by the end of Friday the buck was trading up on the week. Is the worst behind us? Certainly the FX markets think so and the relief rally in the Dow is being mirrored by the relief rally in dollar. If crude continues to drip lower next week it could provide yet another reason for a dollar counter trend rally, however the focus should also return to more mundane micro matters as both US and EZ calendars contain decidedly more event risk than this week.

On the economic front Wednesdays' Beige Book and Friday's Durable Goods data should be of most interest to currency traders. The market is still in a debate over whether US economy is in a mere slowdown or an actual recession and the Beige Book analysis of economic conditions in various Fed districts could shed more light on that issue.

Finally the jobless claims numbers have been surprisingly strong for the past two weeks printing well below the 400K levels that signify recession. Analysts have noted that some of the improvement may be due to seasonal factors. However if this week's data also proves better than expected it would suggest a positive trend with respect to the labor market and would go a long way to making the case that the economy is in a slowdown rather than a full blown contraction. -BS

The Euro € - Danger on the Horizon

In writing about the ZEW survey last week we noted, 'The ZEW reading was worse then even the one at the depth of the 1992 recession but the markets quickly shrugged off the news partly because the ZEW has little direct meaning to the overall economy but mostly because the focus in the currency market right now is strictly on the systemic risk in the US economy and EURUSD is trading purely as a safe haven alternative to the buck.”

Euro's gains over the past two weeks has been the result of nothing more than anti-dollar flows. The unit has hardly displayed any organic strength as the economic data on the continent has been decidedly weak. With US economic concerns stabilized for now, the single currency may no longer enjoy the benefit of safe haven flows and could face a trying week as the fundamental data is forecast to show further deterioration in growth in the 15 member union.

Ahead on the docket this week traders will get a glimpse of the Industrial Production numbers expected to contract -1.0% from the month prior as well as the key IFO report which is forecast to drop to 100.2 from 101.3. If the IFO reading prints even lower, below the psychologically key 100 level the sell of in EURUSD could accelerate as the focus will shift away from the unit status as the pre-eminent anti-dollar instrument back to concerns over its yield. If the data this week proves highly negative, traders will downgrade the chances for any future rate hikes from the ECB and the pair could tumble to 1.5500 level as a result. - BS

The Japanese Yen ¥ - USD/JPY At Critical Point As Risky Assets May Not Hold On To Gains

The USD/JPY pair experienced heavy volatility this week, as risk aversion took hold of the markets at the start of the week. Indeed, the DJIA plummeted below critical support at 11,000 on Monday while the VIX Volatility Index rocketed to the highest levels in three months, as the government's seizure of IndyMac and looming concerns about Fannie Mae and Freddie Mac weighed on the outlook for the financial sector. However, reassurances by Treasury Secretary Henry Paulson that the government would essentially do whatever it had to do in order to keep the two GSEs fully functional helped the DJIA recover nearly 500 points through the end of the week, signaling a return to risk-seeking sentiment and helping the Japanese yen crosses to surge, with USD/JPY gaining nearly 300 pips from the weekly low to end the week just below 107.

As usual, Japanese economic data had very little impact on the low-yielding yen, as risk sentiment market-wide has greater bearing on the currency. Taking a look at the data on hand, condominium sales fell for the 10th consecutive month by 30 percent, while the service sector appears to be taking a heavy hit, with the tertiary index down 0.2 percent and national department store sales down 7.6 percent. Unfortunately, there is little hope of a revival in consumer spending, as tepid wage growth and rocketing food and energy prices squeeze disposable income, and thus, leaves little for discretionary spending. As a result, it is not surprising to see that the Bank of Japan cut its growth forecast during the most recent policy meeting, when the Bank also left the overnight lending rate at 0.5 percent. Meanwhile, the Bank of Japan also raised its inflation estimate, but judged that the economy 'is not facing stagflation.” Overall, it is clear that the Bank of Japan has little room for maneuver when it comes to monetary policy this year, and will likely continue to leave rates unchanged.

Looking ahead to this week, Japanese data is anticipated to reiterate the Bank of Japan's view on the economy: slowing growth and accelerating inflation. The all-industry activity index is forecasted to rise a mild 0.4 percent, though there are downside risks given the drop in the tertiary index. CPI, on the other hand, is expected to jump on the back of energy and food prices. Nevertheless, with risk aversion likely to remain the predominant theme in the markets even in the week ahead, the odds are a bit more in favor of Japanese yen strength (USD/JPY weakness). - TB

The British Pound ₤ - Pound Breaks 2.00 On Dollar Weakness, BoE Minutes Ahead

The pound surged above 2.00 on the back of the Fannie Mae and Freddie Mac concerns. The governments announcement that the GSE's would be extended a line of credit spark broad based dollar weakness. Hotter than expected CPI numbers would sent the Sterling as high as 2.0152 before traders started taking profits. Inflation rose to 3.8% as rising oil and food prices send it well beyond the BoE's 3% threshold. Jobless claims rose by 15,500 and the month priors increase of 9,000 was revised higher to 14,300, as companies cut salaries as the economy slows. The cable weakened on the news falling back below 2.000 where it would end the week.

Inflation accelerated to its fastest pace in 11 years and breach the 3% threshold for a third time. If prices maintain these levels next month then Governor Brown will have to write another letter of explanation to Chancellor Darling on how the central bank intends to bring inflation back to the 2% target. The MPC continues to find its hands tied as each piece of inflation data is followed with continued signs that the economy is headed towards a recession. The weakening labor market is becoming a growing concern for the BoE, as the economy has relied on the resilient British consumer. Additionally, the housing slump shows no signs of slowing as housing prices remained near 30year lows.

The upcoming economic calendar will provide significant event risk as retail sales will cross the wires and the BoE will release their minutes from their last policy meeting where they left their benchmark rate at 5.00%. Traders will be focusing on the consumer consumption data to measure the impact of the weakening labor market. Economists are predicting a 2.6% decline, as they anticipate Britons to have curbed their spending as inflation diminishes their spending power. Weakness in retail sales should weigh the sterling lower. However, a better than expected print could spark a pound rally as resilient domestic growth may be enough to stem a contraction in the economy. The biggest event risk may be the MPC's minutes as the central bank has no clear direction, the tone of the statements could significantly impact price volatility. - JR

The Swiss Franc ₣ - Swiss Franc Rides Dow Rollercoaster As Credit Concerns Return

The Swiss Franc moved in tandem with the Dow Jones Industrial Average for most of the week as the week was filled with whipsaw price action on risk winds and oil prices. The volatility in stocks was triggered by Lehman Brother's warning that Fannie Mae and Freddie Mac could be forced to raise as much as $75 billion in capital to offset write downs and meet new accounting rules. The announcement set up speculation that the mortgage lenders may be insolvent which sparked extreme risk aversion and sent the USDCHF tumbling. A $10 dollar drop in oil prices would see stocks and the dollar rally. The fall in crude was short lived as missile testing in Iran would lead to supply concerns and renew risk aversion which would provide Swiss Franc support. Hank Paulson tried to reassure investors Fannie Mae and Freddie Mac were 'adequately capitalized' in the face of a 'challenging period', when he testified before the House Committee on Financial Services. However, rumors that the government would be rescuing the mortgage lenders would sink the pair
The major event risk on the economic docket is the Swiss retail sales report. Economists are expecting a rebound of 3.8% in May from the month's prior decline of 9.4%. The improvement in consumer consumption may not have that much influence on the pair since the SNB has already established that they have turned their focus away from inflation. Nevertheless, if domestic growth can remain strong, it will reduce the need for the central bank to take measures to promote growth. The following days ZEW survey is expected to show the outlook for the economy progressively getting worse. Ultimately, risk winds may have sway over the pair again, as the fallout from the potential insolvency and takeover of Fannie Mae and Freddie Mac may send investors seeking the safety of the Swiss Franc. However, if the rumors are all smoke and no fire then the USDCHF may reverse its recent losses. - JR

The CAD - Canadian Dollar to Trade off of Retail Sales, CPI Results

The Canadian dollar remained almost exactly unchanged against its US namesake, as an impressive run of Canadian fundamental data was not enough to allow the currency to overcome a modest Greenback recovery. International trade and financial transactions data both surprised strongly to the topside, while a late Wholesale Sales report boosted outlook for domestic consumption. The only disappointment came on surprisingly dovish commentary from the Bank of Canada; officials cited economic risks and lower inflationary pressures as key reasons to leave policy rates unchanged for the foreseeable future. This was a noteworthy shift from the bank's earlier stance, as BoC Governor Mark Carney had previously claimed that economic risks remained towards stronger inflation and more neutral on economic growth. Interest rate traders sent two-year swap rates immediately lower following the release of bank commentary, and the domestic currency likewise slipped against key counterparts on lower rate expectations. The coming week will go a long way in clarifying outlook for the future of domestic yields-two key pieces of economic data will solidify forecasts for price pressures and household consumption.

Tuesday's Retail Sales report and Wednesday's Consumer Price Index figures will likely bring strong volatility to Canadian dollar pairs, as any significant surprises could quickly shift long-term forecasts for Bank of Canada monetary policy. An impressive Wholesale Sales report suggests that we may see similarly robust Retail spending through the month of May-limiting fears that a broad deterioration in business conditions will translate into slower consumer spending. Given that risks for the release remain to the topside, however, the Canadian dollar may stand to sell off aggressively on any disappointments. The following day's CPI data will likewise bring strong price moves to the Loonie, and traders will pay especially close attention to the results of the Bank of Canada Core CPI results.

Given that the central bank is a strictly inflation-targeting monetary policy body, any Core CPI figures above official targets of 2.0 percent could quickly change official stance on price pressures. The Core number's recent drop to 1.5 percent certainly bolstered the case for unchanged BoC rates through the foreseeable future, but a significant pickup in price pressures could undo the moderation in long-term yields. Given the currency market's overall sensitivity to interest rate differentials, we could easily see the Canadian dollar move sharply on above-forecast CPI results. Otherwise, it may result in a relatively quiet week for the USDCAD on a sparse US economic calendar. - DR

The AUD - Static Macro Outlook Sees Aussie Trading Guided By US Dollar Sentiment

Last week's Australian data docket started off in a tame fashion as May's Westpac Leading Index suggested the economy's annualized growth rate fell even further below trend growth of around 4% to register at 2.1% (vs. 2.6% in April). The same day saw RBA Governor Glenn Stevens once again confirm that rate hikes have concluded for this year. Stevens said that 'the chances of keeping Australia's inflation rate low over the medium term are good.” Preliminary estimates of Australian Imports saw volumes decline -2% having expanded 7% in May. The fall was led by a 12% decline in imports of non-industrial transport equipment and an 11% in that of fuels. These developments fell broadly in line with well-defined themes characterizing the Australian economy in recent months: rising energy prices and record-high borrowing costs have depressed consumption, crimped import demand, and put the economy on a path of slowing growth to achieve the policymakers' desired disinflation.

A handful of otherwise secondary releases offered traders with some interesting insights later in the week. June's RBA Foreign Exchange Transaction data revealed that the bank sold A$875 million more than it bought in the spot currency market. This suggests the bank actually had to bring interest rates down to the target 7.25% as the global credit crunch bid up borrowing costs. Interestingly, the Import Price Index printed lower at 1.4% versus expectations of 2.2% as a rise in the cost of oil and other crude materials was offset by a -7.1% drop in the price of other commodities. The reading may prove to be some of the first evidence that the global commodities rally is topping out, with oil prices sticky at higher levels because of crude's status as an anti-US dollar instrument.

This week starts off in stride with Producer Prices for the second quarter. Expectations call for the annualized reading to rise to 5.3% (vs. 4.8% recorded in the first quarter). Businesses pass on higher production costs to their customers by way of higher prices for finished goods, boosting the overall inflation rate. Consumer Prices are also due for release, with expectations calling for an uptick to 4.3% in the year to the second quarter (vs. 4.2% in the first). On balance, both metrics are likely to possess less market-moving potential that usual with an RBA rate hike firmly out of the question in the near term. June's Motor Vehicle Sales are to extend their current downtrend: high borrowing costs make cars difficult to afford while rising petrol prices make them expensive to operate. With few changes likely on the horizon in the broad macro picture of the Australian economy, AUDUSD may once again find itself trading squarely on US dollar sentiment. - IS

The NZD - RBNZ Not Ready to Cut Rates, But Bollard's Comments May Sink the Kiwi Dollar

New Zealand data painted a dark picture of stagflation in the smaller antipodean nation last week. On the growth side, May's Retail Sales underperformed expectations to print at -1.2% versus expectations of -0.1%. The decline was led by automotive and furniture sales, which tumbled -14.8% and -15.6%, respectively. Further, QV House Prices sunk to a new low at 0.1% while the Performance of Services Index fell further below the 50 boom-bust level to print at 45.6. The story is a familiar one at this point - consumers are cutting spending as disposable incomes are eroded by high borrowing costs, booming commodities, and a slumping housing market.

On the inflation side, Consumer Prices set 18-year highs, surpassing expectations of 3.8% to print at 4.0% in the year to the second quarter. Food Prices further reinforced the trend, growing 1.3% in June versus 0.3% expected.

This week's calendar is largely until Wednesday's RBNZ rate decision. June's Credit Card spending is sure to continue downward as Kiwi consumers tighten their belts amid deepening economic malaise. While the recent weakness in the Kiwi dollar may have otherwise helped June's Visitor Arrivals, tourism surely contracted as the global slowdown takes its toll on discretionary spending the world over. In any case, the data is likely to be overlooked as it will take much more than the tourism sector to lift the beleaguered economy out of its current slump. As for the RBNZ, last week's buoyant price growth means Alan Bollard and company will likely delay the promised rate cut until later in the year. That said, Bollard's penchant for unfiltered commentary may see him issue another strongly dovish statement which will no doubt put further downward pressure on the Kiwi dollar. - IS

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