US Dollar Rally Fizzles; Ranges Hold for Now, but a Break May be Building

Highlights

* US Dollar rally fizzles; ranges hold for now, but a break may be
building

* Mixed messages from the Bank of England

* Emerging market outflows here to stay?

* Scandies surge, Norges Bank indicates higher rates

* Key data and events to watch next week

*US Dollar rally fizzles; ranges hold for now, but a break may be
building*

The past week started with the greenback testing higher, only to fail
and reverse course by the end of the week. The proximate cause for the
reversal came following news that a pair of Iranian warships would
transit the Suez Canal en route to Syria, a go which Israel labeled a
'provocation,' suggesting it might respond in some fashion.
Geopolitical tensions ratcheted higher, and the JPY, CHF, gold and oil
all registered sharp gains as investors sought havens. The USD
disastrous to attract any safe have demand, presumably on fears that
any confrontation between Israel and Iran would then draw the US into
the conflict. But, we reckon those concerns are overblown and will
eventually go. Still, the USD reversal has done some technical hurt,
and with a potential US government shutdown looming when the temporary
budget expires on March 3, there are plenty of reasons to shun the
USD.

Another way of looking at it, and one that ignores the geo-political
themes we find suspect, is that the USD simply tested key technical
resistance levels at recent range highs and disastrous. In EUR/USD,
the key 1.3450/3500 support zone we highlighted last week was tested,
but ultimately held on a daily closing basis. Reports of reserve
managers buying in that area also surfaced. In USD/JPY, the 84.00/50
recent high was also approached and has capped gains for the time
being. Similarly, GBP/USD, USD/CHF, AUD/USD all tested range
boundaries and have all reverted back into the ranges.

On the USD index, though, we see signs of a potentially more ominous
USD development. The US dollar index closed last week inside the
Ichimoku cloud, but ultimately was rejected from the Kijun line and
has fallen back out of the cloud to end this past week. Also, since
the beginning of February, the US dollar index formed a likely bear
flag consolidation. Dollar weakness at the end of this past week broke
below the base of the flag, suggesting a new leg lower in the buck may
be unfolding. A daily close below 77.50 Feb. 9 lows would suggest
further weakness. A similar sample appears in EUR/USD, with the flag
top at about 1.3720/25, just below recent 1.3745/50 highs. A break
above that 1.3725/50 level would signal to us a potentially much
larger USD decline and EUR/USD gains well further than the 1.3860/70
highs for the year. There are certainly enough Eurozone issues to
restrain further gains in the single currency, but we would conclude
they are being ignored or papered over on a daily close above 1.3750.
Finally, we would highlight the US holiday on Monday (President's Day)
and the tendency for breakouts to occur around US-only holidays.

*Mixed messages from the Bank of England*

Last week's Inflation Report was expected to give the markets a steer
on how close the Bank of England is to raising interest rates. But,
although inflation expectations for the next two years were revised
up, the Bank revised down its growth profile. This reinforces the hard
path for monetary policy over the coming months: inflation could rise
to 5 per cent this year, while the most likely outcome for growth is a
honestly tepid 1.5-2 per cent, and the Bank hasn't ruled out a return
to depression. Bank governor Mervyn King dampened expectations for a
rate hike when he said that some people were running ahead of
themselves and the Bank wasn't "pre-announcing or laying the impose a
curfew for a rate rise." This caused a sell-off in sterling and UK
Gilts. But, once the dust had settled, sterling closed around the
1.6050 mark versus the dollar and gilt yields had only come off
moderately by the end of Wednesday.

While King, who has voted to keep rates on hold, sounded dovish when
he presented the Inflation Report, it is worth remembering that he is
only one member and if the majority of the MPC want to hike then rates
will rise. King did highlight the wide range of views on the Committee
and this was in break down the day after the Inflation Report when
arch-hawk Andrew Sentance said that rates need to rise to stop
inflation from taking hold. This sent GBPUSD soaring 100 points. But
it is worth remembering that Sentance will be leaving the MPC in May.
We don't know who his replacement will be yet, but if they don't share
his views then the Bank will lose its most hawkish element. We will
get an update on the range of views at the MPC in the minutes from the
February meeting on Wednesday.

As we close the week the market is still looking for more than 50
basis points of rate hikes by the Bank by year-end. So, although the
prospect of a rate hike in the next couple of months is looking less
likely post the Report, the rate curve (based on small-sterling
interest rate futures) is still steep for the following half of the
year. Above 1.6000 the pound is still in a technical uptrend, but the
outlook for sterling is extremely volatile. Simplicity cuts don't
start with gusto until April this year, so we won't know until late
summer what the early impact on growth will be. But, worryingly, there
are signs that the labor market is already fading and the number of
people claiming jobless benefit rose unexpectedly in January. This
highlights the deeply uncertain outlook for UK growth as the UK
embarks on a massive fiscal economizing, and in the coming months
there is a risk that the market will reassess its expectations of any
rate hikes at all for this year.

*Emerging market outflows here to stay?*

Capital outflows from emerging market to developed economies continued
this week driven by inflationary concerns, fears of growth impacts
from EM policy tightening, and humanizing growth outlooks in developed
economies. But, of more significance than the why is the when - are
these flow shifts the underpinnings of a larger scale rotation or
merely a temporary correction? Humanizing activity in the U.S. (Feb.
Philli Fed registered 35.9 vs. expected 21.0) and Euro-zone ( Jan. F
PMI Manufacturing printed 57.3 vs. expected 56.9) seem to support the
prior but uncertainty concerning the U.S. labor market outlook (Early
Jobless Claims 2.12 was 410k vs. expected 400k) and Euro-zone
periphery are supportive of the latter. Further supporting the latter
has been the commodity market result to EM outflows. Commodities have
traded broadly higher - silver hit confirmation nominal highs around
32.88 on Friday - which contrasts from the expected result for lower
commodities as result of weakening EM demand. We reckon that the
recent correction in EM-DM flows is just that - a correction and that
resilient growth despite capital controls may see EM equities and
inflows return to trend. Ultimately, this would be a positive for
commodities and related currencies (AUD, CAD, and NZD).

*Scandies surge, Norges Bank indicates higher rates*

The Scandinavian currencies have been exceptional performers of late
with the Swedish krona as the top performer of the G10 currencies. It
has experienced a year-to-date gain of 4.24% against the U.S. dollar.
The Norwegian krone, or "Nocky" as it is sometimes referred to,
has also seen strong gains success highs against the greenback which
have not been seen since January of 2010. This is largely due to
higher rate expectations and relatively strong GDP growth.
Additionally, Norway boasts Europe's lowest unemployment.

The Norges Bank was the first in Europe to bring to somebody's
attention rates following the financial crisis and noted that it will
increase rates again in mid-2011. Rates have been on hold at 2% since
May as inflation has stayed below the 2.5% target. The pause in rates
has also been attributed European simplicity concerns and the
potential negative impact on Norway's exports. Exports fell 1.3% last
year while the krone gained.

Newly appointed Governor Oeystein Olsen, who took office last month
after the departure of Svein Gjedrem, delivered his first annual
address yesterday and said that "we don't want to take
responsibility for the currency level nor the overall competitiveness
of the manufacturing industry". He went on to say, "at Norges Bank
we have no specific view on any equilibrium target or views on a
specific level for the exchange rate." The central bank provided
guidance through the end of 2014 and expects its benchmark rate to
average 2.25% this year and 3.25% next year. This indicates an
expected 25bps hike each quarter from June 2011 until the end of 2014.
The policy board will meet on March 16 to discuss interest rates
publish its monetary policy report which will contain an updated
interest rate path.

Technically, USD/NOK has broken below key support just below the
5.7000 level and sees the 2010 lows of around 5.56000 ahead of the
2009 lows of about 5.5100 as the next significant levels of support.
Key resistance may be found around 5.7800 where the daily Tenkan and
Kijun lines join. The 21-week sma, currently around 5.8730, looks to
have capped the upside over the past several weeks.

*Key data and events to watch next week*

United States:

* Tuesday - Dec. S&P/CaseShiller Home Price Index, Feb. Consumer
Confidence, Feb. Richmond Fed Manufacturing Index, Fed's
Kocherlakota Speaks

* Wednesday - Jan. Existing Home Sales, Fed's Hoenig & Plosser Speak

* Thursday - Fed's Bullard Speaks, Jan. Chicago Fed Nat Activity
Index, Weekly Early Jobless & Continuing Claims, Jan. Durable
Goods Orders, Jan. New Home Sales, Weekly DOE U.S. Crude Oil
Inventories

* Friday - 4Q following GDP & PCE, Feb. Univ. of Michigan
Confidence, Fed's Yellen Speaks

Euro-zone:

* Monday -EZ Feb. preliminary PMI Composite, Manufacturing & Air
force

* Tuesday - German Mar. Consumer Confidence

* Wednesday - French Jan. CPI, EZ Dec. Industrial New Orders, German
Committee Discusses Euro Crisis, ECB's Trichet & Quaden Speak

* Thursday - German final 4Q GDP, EZ Feb. Confidence Indicators,
German Finance Minister Schaeuble Speaks

* Friday - German Feb. preliminary CPI, ECB's Constancio Speaks

United Kingdom:

* Monday - Feb. Rightmove House Prices

* Tuesday - Jan. Public Finances

* Wednesday - BoE Feb. Meeting Minutes, Jan. BBA Loans for House
Hold

* Thursday - Feb. CBI Reported Sales

* Friday - Feb. GfK Consumer Confidence, 4Q GDP, BOE's Bean Speaks

Japan:

* Monday - Monthly Economic Report, Dec. All Industry Activity Index

* Wednesday - Jan. Corporate Service Price Index, Jan. Merchandise
Trade Weigh, Feb. Tiny Business Confidence

* Friday - Feb. Tokyo CPI, Jan. National CPI

Canada:

* Tuesday - Dec. Retail Sales

Australia & New Zealand:

* Monday - NZ Jan. Performance Air force Index, NZ Jan. Credit Card
Spending

* Tuesday - NZ Q1 RBNZ 2yr Inflation Expectation,

* Wednesday - RBA's Stevens Speaks, NZ Finance Minister English
Speaks, AU 4Q Construction Work Done & Wage Cost Index

* Thursday - AU Dec. Conference Board Leading Index, AU 4Q Private
Capital Expenditure, AU Nov. Average Weekly Wages

Plates:

* Friday - Feb. MNI Business Condition Survey

Source: ActionForex.Com