Dollar on the Ropes

[U][B]Talking Points[/B][/U]
$ Dollar on the Ropes
€ Will Euro Finally Turn From Record Highs?
¥ Yen Strength Proves To Be Dependent Upon Risk Aversion
? British Pound Could Topple Amidst Softer CPI, GDP
? Swissie Could Continue To Gain On Signs Of Inflation, Expansion
C$ Bank of Canada Raises Rates, but How Far Will They Go?
AU$ Australian Data Remains Positive, Further AUD Gains in Store?
NZ$ CPI Report Leaves Risks to Downside for New Zealand Dollar

[B]Dollar on the Ropes[/B]
The horrid Retail Sales numbers which printed at -0.9% vs. 0.2% expected broke the will of the last standing dollar bulls and pushed the EURUSD to all time highs above the 1.3800 level in early New York trade on Friday. The data made it crystal clear that despite the relatively buoyant employment numbers the US consumer is now in a deep funk as the Mortgage Equity Withdrawal spigot has been completely shut off providing no alternative source of income aside from the relatively stagnant wages. In fact credit card borrowing jump4ed to its highest levels in 6 months in May suggesting that the US consumer has turned to his last source of available funds. None of this of course bodes well for second half growth as spending which makes up more than 70% US GDP is likely continue to be drag on the overall economy.
Next week the calendar offers little hope to greenback bulls unless it provides a series of upside surprises. The middle of the week should set the tone with Industrial Production on Tuesday of key importance followed by Housing starts on Wednesday. If manufacturing aided by the weak dollar continues to perform well then it will be the one bright spot in the US economy, providing a small offset to the gloomy consumer news. Furthermore, should housing data on Wednesday suggest some stabilization then we may have a reflex rally on the assumption that the worst is over. Yet these are all thin reeds of hope to base an argument for a EURUSD top. The one strong reason may be sentiment. Our proprietary SSI gauge is flashing gross imbalances in positioning suggesting that a pause in the uptrend may be near. -BS

[B]Will Euro Finally Turn From Record Highs?[/B]
Euro bulls were out in full force last week, helping to set new record highs against the US dollar and the Japanese yen, with EUR/USD peaking at 1.3813 and EUR/JPY surging to 168.85. The impetus was from an unexpected revision to first quarter GDP to 3.1 percent from a year earlier, led by business investment and surprisingly, export growth. In fact, exports were revised up to 0.8 percent from 0.3 percent, signaling that the appreciation of the euro did little to quell demand for European products. Furthermore, with expansion in the Euro-zone remaining so resilient, the European Central Bank will be more likely to enact policy tightening this year. However, markets will first need to see a pick up in price pressures before ramping up their bets on a hike to 4.25 percent, as CPI is still below the bank?s 2.0 percent ceiling.
It just so happens that CPI for the month of June will be released this week, and estimates are for a slowdown to 0.1 percent growth on a monthly basis while the annual rate of growth is expected to hold at 1.9 percent. With EURUSD at such elevated levels and showing hesitance to stay above 1.3800, only the most bullish data out of the Euro-zone will be able to give way to a rally. Moreover, with the ZEW survey on Tuesday estimated to fall back to 19.7 from 20.3, it appears that declines towards 1.3600 may be in store for the euro this week. On the other hand, FXCM SSI has shown that traders are aggressively selling the currency in an attempt to call a top, which may signal buying opportunities for the currency. For more on that report, see the most recent SSI report by Antonio Sousa, Currency Analyst. - TB

[B]Yen Strength Proves To Be Dependent Upon Risk Aversion[/B]

The Japanese yen made substantial gains last week as a bout of risk aversion on Tuesday permeated throughout the forex, bond, and equity markets. News that the S&P may cut ratings on $12 billion worth of subprime mortgage-backed bonds sent traders flocking to safer havens, as USDJPY plunged over 200 points towards 121.00. 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. Meanwhile, the Bank of Japan maintained steady rates following their July policy meeting, as the economy remains in deflation and with the LDP elections occurring at the end of the month. So does this mean the lack of political pressure will lead BOJ Governor Fukui will move to normalize rates in August? There is certainly speculation that he and his fellow policy makers will discuss such a move, but they will face substantial resistance from the government, as officials such as Kozo Yamamoto and Shigeyuki Goto have recently spoken out against such measures.
Looking ahead to this week, the Japanese yen is likely to remain soft as fundamental data is anticipated to highlight the tepid state of the economy. First, the Tertiary Industry index is estimated to rise 0.2 percent - down from 1.7 percent the month prior - potentially signaling that the surge in the performance of the services sector last month was simply a one-off event. This indicator can be a market mover, especially as it contributes over 60 percent to the All-Industry Activity index, which is scheduled to be announced later in the week. As a result, a sharp decline in the services sector report will not bode well for the broader industry figure later in the week. Another thing to watch is the recent news that Iran has requested that Japanese refiners pay for crude oil purchases in yen rather than dollars, after the Iranian central bank said they would cut holdings of the greenback. If this starts to become a trend, the move to yen-based transactions could be quite bullish for the currency in the long-run. In the near-term, however, technical levels appear to favor further losses for the low-yielding currency, as USDJPY just barely held above a supporting ascending trendline starting from the March lows. Furthermore, Elliot Wave patterns also back gains for USDJPY, as noted in Friday?s DailyFX Technicals by our Technical Strategist, Jamie Saettele. - TB

[B]British Pound Could Topple Amidst Softer CPI, GDP[/B]
The British pound hit fresh 26-year highs once again last week as hawkish commentary from MPC members of the Bank of England kept hopes for another hike to 6.00 percent alive. On Friday, Bank of England Chief Economist Charles Bean noted that central banks should maintain focus on headline inflation data rather than core readings in order to better anchor inflation expectations. The news suggests that the UK central bank will continue to pursue a tightening course, especially as oil trade above $70/bbl and is bound to keep headline CPI above the 2.0 percent target and making policy tightening even more likely in coming months. Meanwhile, the UK trade deficit surprisingly shrank to its lowest level in more than a year. The news is positive for Cable bulls as it demonstrates that higher currency rates have not materially hurt UK exporters. In fact, the improvement in the deficit was the result of stronger exports as demand from the Euro-zone went undeterred despite the appreciation of the British pound.
Similar to the EURUSD, GBPUSD has tested resistance and subsequently backed down. In fact, the pair has formed a triple top at 2.0365 - a particularly bearish implication. Furthermore, economic data out of the UK this week may only make this a self-fulfilling prophecy, as inflation pressures are anticipated to soften. CPI for the month of June is estimated to fall to 2.3 percent on an annual basis from 2.5 percent, while both retail sales for the month of June and GDP for the second quarter are predicted to ease, indicating that the Bank of England?s previous policy actions have started to make an impact and lessening the need for further rate hikes. As a result, the release of CPI on Tuesday could spark a precipitous plunge for GBPUSD with the next level of support near 2.0250. - TB

[B]Swissie Could Continue To Gain On Signs Of Inflation, Expansion[/B]
Overt weakness in the US dollar translated into massive gains for the Swiss franc last week, as USDCHF has plummeted almost 200 points to the 1.2000 despite the fact that absolutely no Swiss data was released. Nevertheless, traders continue to look forward to another round of rate normalization by the Swiss National Bank as the interest rate curve is pricing in two quarter point hikes by the end of the year.
This is not entirely unrealistic, as the Swiss central bank raised its expectations for GDP this year to 2.5 percent from 2 percent after the June policy meeting. The Swissie has been strong against other currencies as well, especially the Japanese yen, as the divergence between Swiss and Japanese interest rate expectations propelled CHFJPY to hit new 16 year highs of 101.84.
Looking to this week, Swiss economic data may allow USDCHF to continue working down towards the 1.1900 level, as retail sales should signal that consumption growth will keep expansion on track. Adjusted real retail sales are anticipated to pick up in May - but given the volatility of this particular release, traders don?t usually put too much weight on its result. Nevertheless, signs of resilient consumption bode well for the economy as a whole. Meanwhile, the trade surplus should hold aloft, as strong growth throughout the Euro-zone will like keep demand for Swiss products steady. Finally, producer and import prices are estimated to gain, which could add a bid tone to the Swiss franc, as signs of mounting inflation pressures will only lead traders to ramp up speculation of a hike by the Swiss National Bank in September. - TB

[B]Bank of Canada Raises Rates, but How Far Will They Go?[/B]
The bank of Canada took rates 25 basis points higher to 4.50 percent on the week?s meeting, but uncertainty over future monetary policy tightening left the currency slightly weaker in the moments following the report. In its post-hike communiqué, the bank gave mixed signals on overall outlook for growth and inflation. It said that Core CPI would set a peak of 3.0 percent through 2007?a full percentage point above official targets at 2.0. This would arguably call for an extended policy tightening cycle, but the bank said that only “some modest further increases in the overnight rate may be required to bring inflation back to target over the medium term.” BoC Governor David Dodge made explicit reference to the domestic currency?s strength as a reason that inflation would moderate, likewise saying the Loonie?s multi-decade highs would limit economic expansion through the period. Such overt reference to the exchange rate spooked many USDCAD shorts and forced a strong retracement on the day. The net effect was far less pronounced, however, as the pair set fresh lows on stronger-than-expected Canadian Housing figures.
Markets are left to wonder whether the CAD may stage a stronger retracement of overextended gains. A relatively moderate update to the Bank of Canada?s April Monetary Policy Report suggests that markets have priced in too high a probability of rates at 5.00 percent through December. The strong Loonie may in fact be its own undoing, with its pronounced appreciation limiting the central bank?s motivation to raise rates aggressively to combat inflation. Combined with overextended USDCAD short positioning, the currency pair may be setting up for a short-term retracement.
The coming week of economic data will be comparatively light, but a key Consumer Price Index report promises strong volatility through Wednesday trade. Central bank officials forecast that the Core CPI rate will reach a peak of 3.0 percent through year?s end, with analysts forecasting a 2.6 percent print through June. Indeed, the bar has been set relatively high for the price index and this may in fact leave risks to the downside for the Canadian dollar. A positive surprise has, to some extent, been priced in following the BoC?s aggressive forecasts. Should CPI come in below forecasts or?worse still?below May?s results, we could see a sharp CAD sell-off (USDCAD rally) on the data. Otherwise, markets are left to trade off of developments in the US and a mid-tier Canadian Leading Indicators news release. - DR

[B]Australian Data Remains Positive, Further AUD Gains in Store?[/B]
Relatively mixed economic data was not enough to slow the Aussie?s continued ascent, with the AUDUSD trading to fresh 18-year highs through the week. The long-anticipated Australian Employment Change report was the clear highlight of event risk. A disappointment in the headline caused an initial AUD tumble across the board. A very material upward revision to the previous month?s data completely offset such a disappointment, however, as the domestic economy was said to have added over 43,000 jobs in the month of May. From a grossly oversimplified perspective, this would be the rough equivalent of a 600k gain in the monthly US Non Farm Payrolls report. Such undeniable employment strength remains one of the bright spots for the domestic economy, with markets continuing to speculate that robust spending will force higher interest rates through year-end. The coming week will offer very little in the way of new data, however, leaving the Aussie to trade off of carry trade interest through the short term.
Thursday?s Import Price Index represents the sole piece of notable event risk through the coming days, with markets expecting the strong AUD to hold back notable gains in the trade-linked measure. If prices fail to moderate, however, the Aussie may potentially see a bid on increased expectations for monetary policy tightening. Otherwise, look to the performance of global equity markets and the Japanese Yen to gauge the likelihood of a further Australian Dollar advance. From a technical analysis standpoint, our own analyst Jamie Saettele predicts that the AUDUSD may retrace before forging fresh multi-decade highs. See here for more: EURUSD Pattern Indicates Potential For Sharp Reversal. - DR

[B]CPI Report Leaves Risks to Downside for New Zealand Dollar[/B]
The New Zealand dollar rallied just short of post-float highs as a pronounced return to risk aversion fueled popular high-yielding currency pairs. New economic data was limited to a late-week Retail Sales report, which more than doubled consensus estimates at a 1.2 percent gain. The bullish result was enough to force an NZDUSD move to 0.7877, but subsequent retracement sets what appears to be a triple-top in said zone. Technically, it seems as though the Kiwi-US dollar is primed for pullback, with sharply overbought oscillators holding back further upward momentum. Whether or not this comes to bear will be contingent on overall market risk aversion, but a recent RBNZ announcement to establish net exchange reserves in foreign currencies may tip the scale in favor of Kiwi weakness. Though markets largely ignored the report, the news signals that the RBNZ will effectively hold net short positions on the NZD on a longer term basis. This event notwithstanding, markets now look to the coming week?s key CPI report for guidance on the future of NZDUSD performance.
Economists predict that New Zealand Consumer Prices gained 0.8 percent through the first quarter?a sizeable 0.3 percentage point acceleration from Q4, 2006. Favorable base effects leave year-over-year forecasts at a much more reasonable 1.8 percent rate, but such a result would nonetheless signal rising price pressures through the medium term. The Reserve Bank of New Zealand has shown little hesitation in raising rates to continued record-highs, now at 8.25 percent, predicting that excessive spending may undermine price stability. Markets will view the upcoming report as a confirmation that such monetary policy tightening was indeed warranted, with any disappointments to almost certainly caused sustained NZD declines. Conversely, it would take a very strong upward surprise to force a worthwhile rally in the Asia Pacific currency. An otherwise empty week of data will leave the Kiwi to trade off of broader performance of risky assets. - DR