US Dollar - Is This Reversal Just the Beginning of a Bigger Move?

US Dollar - Is This Reversal Just the Beginning of a Bigger Move?
The US dollar fell sharply across the majors on Friday as US retail sales and producer prices proved to be broadly bearish and unsupportive of speculation that the Federal Reserve is hawkish enough to consider raising interest rates before year end. US Advance Retail Sales fell more than expected by 0.3 percent in August, marking the second consecutive month of contraction. Looking at a breakdown of the index, spending in nearly every component declined, led by building materials, gasoline stations, and department stores. It is worth noting, though, that this index is not adjusted for inflation, so the drop in the gasoline station component may only be indicative of the drop in gas prices during August (rather than a drop in demand). Nevertheless, consumption is widely anticipated to be a soft spot for the US economy going forward, as the housing sector has yet to recover for some time, credit conditions remain tight, and the unemployment rate rises. In fact, during August, the unemployment rate surged to a 5-year high of 6.1 percent with non-farm payrolls contracted for the eighth consecutive month.

Looking at the other release on hand, US producer prices fell by the most in nearly 2-years during August, as the index tumbled 0.9 percent for the month and slowed to an annual pace of 9.6 percent from 9.8 percent. The decline was led, unsurprisingly, by energy as crude oil plummeted over the course of the survey period. However, excluding this fact, producer prices rose 0.2 percent during the month thanks to continued food cost increases. Overall, the data should quell some of the speculation that the Federal Reserve will move to raise rates before year end, as we actually saw that fed fund futures were pricing in a slight 14 percent chance of a 25bp cut at the next meeting on September 16. While this is highly unlikely, that sort of sentiment was just what dollar bears needed to get back in the game and this move could continue throughout next week, though much of that will depend on the Federal Reserve’s policy statement on Tuesday and what sort of bias it reflects.

British Pound Rockets 2% Higher, More Gains May Be In Store
There was no UK data on hand on Friday, but if there had been, it probably would’ve been disappointing. Indeed, there’s no doubt in anyone’s mind that the Bank of England is in a very tough spot at this juncture, as the UK economy teeters on the brink of recession while inflation pressures remain strong. That doesn’t mean the British pound can’t gain in these circumstances though. It took a few days, but my DailyFX Analyst Pick from Monday is finally working out, as GBP/USD rocketed higher on Friday as the overextended decline in the pair finally started to correct. According to the latest FXCM SSI numbers, GBP/USD shorts jumped 16 percent, and as a contrarian indicator, the data signals additional gains. While my bias for the British pound remains bullish for much of next week, the currency faces hefty event risk. On Tuesday, UK CPI is expected to accelerate even faster to a 4.6 percent annual pace, which would mark the sharpest rise since May 1992. On Wednesday, the Bank of England’s meeting minutes - a huge market-mover for the British pound – will hit the wires and could show yet another split vote and biased commentary. Finally, on Thursday, UK retail sales are forecasted to fall 0.5 percent, dragging the annual rate to a more than two year low of 1.6 percent and adding to the pile of evidence signaling a potential recession.

Euro Rallies 200+ Points, Breaks Trendline Resistance
The Euro rallied extended 2.3 percent higher against the Japanese yen and 1.6 percent versus the US dollar as the oversold currency finally reversed. In fact, looking at recent FXCM SSI readings, EUR/USD positioning flipped from net long to net short on Friday, and as a contrarian indicator suggests the pair could gain further. However, there is still quite a bit of rate cut speculation, as Credit Suisse overnight index swaps are now pricing in nearly 50bps in reductions by the ECB over the next 12 months, compared to 25bps in cuts just two weeks ago. Thus, from an interest rate perspective there’s still downside risk for the euro, and there is notable resistance looming above at the 38.2% fib of 1.4812 – 1.3880 at 1.4236. While I do see potential for EUR/USD to pullback when trading resumes on Sunday, my bias for the euro remains bullish for much of next week.

Japanese Yen: The Only Currency Weaker Than the US Dollar
Like the US dollar, the Japanese yen tumbled across the majors, but losses for the low-yielding yen were hefty as the currency lost nearly 3 percent against high-yielders like the British pound and Australian dollar. The move had more to do with sharp reversals in oversold currencies like the Euro and British pound, but with the Japanese Yen interest rate forecast looking neutral, the currency will be particularly vulnerable to choppy price action. Meanwhile, Japanese data was extremely weak overnight as the final revision of Q2 GDP confirmed that the world’s second-largest economy shrank 0.7 percent during the quarter and contracted 3 percent from a year earlier. Since Q1 GDP fell 0.6 percent, Japan is now officially in recession (strict definitions of recession refer to two consecutive quarters of negative economic growth). As a result, the Bank of Japan will likely stick to a loose monetary policy by keeping borrowing costs unchanged at 0.50 percent through the next year, though BOJ Governor Shirakawa’s scheduled speech late next week could yield some bearish commentary on the economy.

US Dollar Remains Overbought - Prone to Reversal?

US Dollar Remains Overbought - Prone to Reversal?
Indeed, according to COT forex positioning, the dollar is extremely overbought, suggesting we may be nearing a point where risk/reward warrants selling the greenback. We’ve seen some incredibly volatility in the currency, as the EUR/USD and GBP/USD pairs traded in more than 100 pip ranges. When it comes down to it though, the dollar still ended Tuesday up very slightly versus most of the majors (though it fell against the Japanese yen). Looking at the economic data on hand, US pending home sales fell 3.2 percent, as fewer Americans signed contracts to buy homes. Such a decline is not incredibly surprising, as demand for homes remains extremely weak given the US economic slowdown and more stringent lending standards. Meanwhile, wholesale inventories rocketed 1.4 percent in July while wholesales sales slipped 0.3 percent, suggesting that lackluster demand is leaving firms stuck with excess supplies. This does not bode well for this Friday’s advance retail sales release, especially given the continued deterioration in the US labor markets as indicated by last week’s US non-farm payrolls (NFPs) report.

Japanese Yen the Currency of Choice as Increase in Investor Confidence Proves Short-Lived
Monday’s surge in carry trades and the Japanese yen crosses subsequently saw a sharp reversal on Tuesday, as the increase in investor confidence following the US government’s seizure of Fannie Mae and Freddie Mac proved to be short-lived. Indeed, the DJIA – which gained 2.58 percent on Monday – plunged 2.43 percent on Tuesday, as 11,500 provided solid resistance. Meanwhile, the Japanese yen gained over 1 percent versus the Euro, British pound, and US dollar while jumping nearly 2 percent against the New Zealand dollar and 3 percent against the Australian dollar. As usual, Japanese fundamentals has little bearing on the currency, as the latest forex correlations report shows that carry trades and the DJIA have increasingly been moving in lockstep (though the correlation is not as high as it was in 2007). Going forward, the Japanese yen will continue to depend on the status of risk appetite in the market, and the evolution of the Fannie Mae/Freddie Mac story will certainly be one worth following.

British Pound Creeps Higher Despite Weak UK Data – Time to Buy?
The British pound climbed throughout the trading day following Monday’s test of 1.75 as COT forex positioning shows that the currency remains oversold and other indicators suggest potential GBP/USD buying opportunities. However, UK economic data remains overwhelmingly bearish, as UK industrial production failed to rise for the fifth consecutive month in July as mining, quarrying, oil, and gas output drops. The news comes on the tails over yesterday’s weaker-than-expected producer price numbers, which indicated that the Bank of England may be able to let their guard down sooner rather than later when it comes to inflation risks, especially since the central bank is already grappling with the issue of a rapidly deteriorating economy. This is much of the reason why Credit Suisse overnight index swaps are pricing in nearly 100bps worth of rate cuts by the Bank of England over the next 12 months, and if the official UK CPI numbers (due to be released on 9/16) signal that inflation is not accelerating as quickly as they expected, the central bank could start reducing interest rates before year-end. Thus, from a fundamental perspective, downside risks remain for the British pound, but from a technical perspective, I believe GBP/USD is due for a bounce from current levels.

Euro: Why the ECB Will Not Cut Rates Until 2009
The euro consolidated above 1.41 towards the end of the US trading session on Tuesday, as the US dollar remains relatively strong across the majors, but like the British pound, there are technical indications that EUR/USD could advance. Meanwhile, from a fundamental perspective, much of the EUR/USD decline has been due to speculation that the European Central Bank will cut rates while the Federal Reserve will hike. Last week, we saw the ECB leave rates unchanged at 4.25 percent, and as expected, ECB President Trichet remained hawkish on inflation and somewhat bearish on economic prospects, especially since ECB staff projections for growth were revised down for 2008 and 2009. Overall, though, ECB voting members remain focused on their primary mandate of price stability, suggesting the 25-50bps worth of cuts expected during the next 12 months will not occur until 2009. If this starts to become clear to the markets, the euro may finally have the fundamental impetus to recover.

Australian Dollar, New Zealand Dollar Hit Hard By Risk Aversion – Will the RBNZ Cut Rates?
The Australian dollar and New Zealand dollar both tumbled on Tuesday amidst a return to risk aversion, as carry trades throughout the financial markets experienced a sharp reversal. Economic news was limited, though Australian retail sales did edge slightly higher during the month of July. In a new monthly trend series, the government reported a 0.1 percent gain, matching the June reading. However, this report may now be less reliable since it takes into account a significantly smaller sample size, and will make it a bit more difficult for policy makers to gauge consumer spending, which accounts for approximately 60 percent of economic growth. The biggest piece of event risk by far, though, will be the Reserve Bank of New Zealand’s rate decision, since they are expected to cut rates for the second consecutive month by 25bps to 7.75 percent, according to 14 of the 15 economists polled by Bloomberg News. It is telling, though, that the last economist actually anticipates a 50bps cut. The key to the New Zealand dollar’s reaction, though, will be RBNZ Governor Bollard’s post-meeting commentary. Credit Suisse overnight index swaps are already pricing in nearly 150bps worth of rate cuts within the next 12 months, but if Mr. Bollard mimics his dovish policy statement from July, this sentiment will be exacerbated and the New Zealand dollar will likely plunge.

US Dollar Gets a Boost from Fannie/Freddie Intervention…For Now

US Dollar Gets a Boost from Fannie/Freddie Intervention…For Now
Indeed, many have taken the intervention as the answer for the ailing US housing sector and financial markets. While the operation of Fannie Mae and Freddie Mac is good for the trading of mortgage-backed securities, in that there will be a party willing to buy the risky assets, it does not mean the values of them will improve. In order for these values to rise, US property values will need to increase first and there is no single solution for this. In reality, another major factor working against a recovery in housing is the slowing in the broad US economy, especially given last week’s worse-than-expected labor market reports. US non-farm payrolls (NFPs) fell 84,000, marking the eighth consecutive month of job losses in August, while the unemployment rate picked up to a 5-year high of 6.1 percent. Nevertheless, Credit Swiss overnight index swaps (OIS) are still pricing in over 50bps worth of hikes by the Federal Reserve within the next 12 months as the Federal Open Market Committee said during their last meeting that "the next policy move would likely be a tightening," though they did specify that any changes would "depend on evolving economic and financial developments.” Overall, I think this US dollar rally stemming from the Fannie/Freddie news is one to be leery of, and given the vastly overbought nature of the currency, we may be nearing a point where risk/reward warrants selling the greenback.

Japanese Yen Falters as Traders Return to Carry Trades
In the aftermath of the news of the US government’s seizure of Fannie Mae and Freddie Mac, the US dollar wasn’t the only currency to react strongly. Indeed, the Japanese yen finally pulled back against many of the majors, especially the high-yielding New Zealand dollar and Australian dollar, as traders saw the announcement as a green light to pile into carry trades. However, as we mentioned in our discussion of the US dollar, traders should be leery of these moves as the ultimate benefits of the GSE bailout (Government Sponsored Enterprise) may be limited for the financial markets and US housing sector. In Japanese economic news, the Eco Watchers survey of business conditions fell to a nearly 7-year low of 28.3 from 29.3. With wage growth slowing and the Japanese economy on the brink of recession, it is unsurprising to see that businesses are less optimistic about their prospects going forward. Nevertheless, this news really had little bearing on Japanese yen price action, as our latest forex correlations report shows that carry trades and the DJIA have increasingly been moving in lockstep (though the correlation is not as high as it was in 2007). Going forward, the Japanese yen will continue to depend on the status of risk appetite in the market, and the evolution of the Fannie Mae/Freddie Mac story will certainly be one worth following.

British Pound Experiences Heavy Volatility Trading in Massive 500 Point Range
Trading in the British pound had more to do with US dollar price action, but the moves were notable nonetheless. GBP/USD managed to trade in a nearly 500 point range of approximately 1.75 – 1.80, but ultimately ended the day by consolidating in a smaller range of 1.7550 - 1.7625. Looking at the data on hand, the UK producer price index reflected declines in both input and output prices during the month of August, as the former fell 2.0 percent and the latter slipped 0.6 percent, marking the sharpest drop since record-keeping began in 1986. The declines were due primarily to a reported 4.8 percent plunge in petroleum product prices, but energy was not the sole factor as even core output prices slipped 0.1 percent. Overall, the data suggests that the Bank of England may be able to let their guard down sooner rather than later when it comes to inflation risks, especially since the central bank is already grappling with the issue of a rapidly deteriorating economy. This is much of the reason why Credit Suisse overnight index swaps are pricing in nearly 100bps worth of rate cuts by the Bank of England over the next 12 months, and if the official UK CPI numbers (due to be released on 9/16) signal that inflation is not accelerating as quickly as they expected, the central bank could start reducing interest rates before year-end. Thus, from a fundamental perspective, downside risks remain for the British pound. However, the currency is also greatly oversold.

Euro Ends Day Down Nearly 300 Points From Intraday High
The euro collapsed 300 points from the intraday high during the European and US trading sessions to end the day near 1.4150 as investors bought up risky assets and signaled confidence in US assets. There was no European data on hand, but there was central bank commentary on hand that would normally provide a bullish spark for the euro. Indeed, European Central Bank Executive Board member Juergen Stark noted the materialization of “second-round” inflation effects from energy and food prices, saying that wages were rising at “annual rates Fnot seen since the mid-1990s.” The ECB has frequently cited a need to maintain price stability so as to avoid these “second-round effects,” and as a result, it is clear that the central bank will not even consider cutting rates anytime soon. While Credit Suisse overnight index swaps may be pricing in over 25bps worth of cuts within the next 12 months, I do not expect the ECB to do so until Q4 2008 or early 2009. Furthermore, like the British pound, the euro remains extremely oversold and there are indications that EUR/USD could advance.

Australian Dollar, New Zealand Dollar Surge on Demand For Yield
The Australian dollar and New Zealand dollar both surged on Monday thanks to a new-found demand for risky, high-yielding assets. While the Reserve Bank of Australia and Reserve Bank of New Zealand are both expected to cut rates by at least 100bps over the next 12 months, the central banks still hold some of the highest benchmarks in the G10 (RBA: 7.00 percent, RBNZ: 8:00 percent). However, commodity prices – which hold a strong correlation with the Aussie – ended the day very little changed. Traders shouldn’t brush off that correlation though. If the market’s attention turns away from Fannie Mae/Freddie Mac and back to commodities, oil and gold could become the big driver of the commodity dollars once again. Meanwhile, event risk will pick up significantly for the comm bloc this week. The biggest by far will be the Reserve Bank of New Zealand’s rate decision, since they are expected to cut rates for the second consecutive month by 25bps to 7.75 percent, according to 13 of the 14 economists polled by Bloomberg News. It is telling, though, that the last economist actually anticipates a 50bps cut. The key to the New Zealand dollar’s reaction, though, will be RBNZ Governor Bollard’s post-meeting commentary. Credit Suisse overnight index swaps are already pricing in nearly 150bps worth of rate cuts within the next 12 months, but if Mr. Bollard mimics his dovish policy statement from July, this sentiment will be exacerbated and the New Zealand dollar will likely plunge. Meanwhile, New Zealand retail sales, Australian retail sales, and the Australian net employment change are all likely to be negative fundamental factors for Kiwi and Aussie.

US Dollar: What Impact Will Non-Farm Payrolls Have?

US Dollar: What Impact Will Non-Farm Payrolls Have?
Working in favor of US dollar strength was the release of ISM services unexpectedly improved in August to a reading of 50.6 from 49.5, with the rise above 50 signaling an expansion in the sector for the first time since May. A breakdown of the report, though, suggests that the headline reading may be a bit deceiving. While price growth appears to be slowing, domestic and export orders both continue to contract, as those indexes held below 50. Furthermore, the employment component slipped to 45.4, signaling weakening labor conditions for the fourth consecutive month. This certainly does not bode well for Friday’s US non-farm payrolls (NFPs) report, which is anticipated to show 75,000 job losses. However, the NFP report has not been the huge market-mover it once was for the greenback, and may have little bearing on whether or not the currency continues to gain or fails.

Japanese Yen Gains Over 2.5% Against High-Yielders on Fears of ‘Financial Tsunami’
We know that risk sentiment remains the primary driver of the Japanese yen because political turmoil has recently emerged and Japanese economic data has been absolutely abysmal, but yet the low-yielding currency has remained strong against its foreign counterparts. This remains the case, as the currency gained across the majors, but especially so against the high-yielding Kiwi and Aussie dollars. What gives? With global credit risks remaining high and equity markets susceptible to sharp decline, traders deleveraging and pulling money out of carry trades. Furthermore, calls by PIMCO manager Bill Gross for the US government to bail out mortgage lenders like Fannie Mae and Freddie Mac rattled investor confidence, as he suggested lack of action would lead to a “financial tsunami.” Downside potential remains for the credit and equity markets, and as a result, my bias for the Japanese yen going forward versus most of the majors: bullish.

Canadian Dollar: Canada’s NFPs to Determine Next Move For USD/CAD
Yesterday I said that, from a technical perspective, it appears that commodity currencies like the Canadian dollar, Australian dollar, and New Zealand dollar may all be due to recoup some of their massive losses. However, at the end of Thursday’s trading session, AUD/USD and NZD/USD broke below former trendline support, while USD/CAD breach falling trendline resistance dating back to mid-2004. Looking ahead to Friday, the Canadian dollar will be the only commodity currency to face event risk, but it could actually prove to be the news of the day. The Canadian net employment change is forecasted to rise 10K in August compared to drop of 55.2K in July, while the unemployment rate is anticipated to edge up to 6.2 percent. The employment change is notoriously difficult to predict, especially since our main leading indicator for this – the employment component of Ivey PMI – will not be released until later in the morning. As a result, the data should be especially market-moving, with a strong reading likely to push USD/CAD lower, though a disappointing negative result should send the pair surging above noted trendline resistance.

Euro Breaks Below Key Support as Comments by ECB’s Trichet Stay Status Quo
The euro fell nearly 1 percent on Thursday, as EUR/USD tumbled and broke below the 38.2 percent fib of 1.1638 – 1.6041 at 1.4358. This was important as it also marks the region where we have the December 2007 lows, which could make it difficult for the pair to drop much lower. The European Central Bank’s rate decision was essentially a non-event, as they opted to leave rates steady at 4.25 percent as expected and ECB President Jean-Claude Trichet’s post-meeting press conference yielded little no information. Mr. Trichet maintained that inflation will likely remain “well above” their 2 percent target for a “protracted period of time,” and that current interest rates will help the ECB maintain their primary objective of price stability. However, ECB staff projections for real GDP growth were revised down to a range between 1.1 percent and 1.7 percent in 2008 and between 0.6 percent and 1.8 percent in 2009. Furthermore, risks to the outlook were noted as being “particularly high”, with downside risks prevailing. Overall, this was supportive of interest rate expectations, as Credit Suisse overnight index swaps price in over 25bps worth of cuts by the ECB during the next 12 months. On Friday, the status of the euro will depend greatly on the US dollar, as there are no key European economic releases scheduled.

British Pound Collapse Continues As House Prices Plunge 10.9%, BOE Leaves Rates Steady
The British pound has plunged nearly 2,500 points since mid-July, and ended Thursday testing 1.7575 as the outlook for the UK remains grim. The Bank of England’s rate decision was essentially a non-event, as the left rates at 5.00 percent and did not issue a monetary policy statement (since there was no change in rates). Nevertheless, Credit Suisse overnight index swaps are still pricing in nearly 100bps in rate cuts by the BOE within the next 12 months, as HBOS house prices fell 10.9 percent in August from a year earlier. The UK housing market remains in shambles, with the sector’s recession rivaling that of the US. The fear amongst UK central bankers is that it will have a similar impact on not only the economy at large, but also the credit markets.

ECB President Trichet’s Comments Could Shake Up the Markets, Expected to Leave Rates At 4.25%

Euro: ECB President Trichet’s Comments Could Shake Up the Markets, Expected to Leave Rates At 4.25%
Euro-zone retail sales fell more than expected by 0.4 percent in July. Nevertheless, the key to the euro this week will almost certainly be the European Central Bank’s policy meeting. They are widely anticipated to leave rates steady at 4.25 percent, but as usual, ECB President Trichet should be the bigger market-mover as his commentary tends to be biased and direct. In fact, the latest EUR/USD bear leg was sparked by his comments on August 7, as he turned his attention away from inflation to slowing growth. Since the ECB’s last meeting, evidence continued to point toward a sharp economic slowdown, while CPI estimates for August unexpectedly slipped to an annualized rate of 3.8 percent, down from the official July reading of 4.0 percent. That said, CPI is still well above the ECB’s 2 percent target. The news is in line with Credit Suisse overnight index swaps, which are pricing in just over 25bps worth of rate cuts within the next 12 months. In the end though, Mr. Trichet’s comments could prove to be a non-event, as his stance in unlikely to shift dramatically from last month.

US Dollar Rally Shows Signs of Pausing, ISM Serves Expected To Signal Contraction
The US dollar may have ended the day higher against many of the majors, but there are indications that the tide may be turning for the greenback. First, the plunge in crude oil futures - which has supported much of the dollar’s gains - has started to cool down. Next, Credit Suisse overnight index swaps, which priced in 62bps worth of Federal Reserve rate hikes over the next 12 months on Tuesday, have backed off to price in 49bps as of Wednesday’s close. US economic news proved to be a non-event, as the Fed’s Beige Book was similar to previous releases, noting that consumer spending is weakening while price pressures remain an issue for most industries. Thursday’s US data, however, should be a bit more market-moving with ISM non-manufacturing (services) scheduled to be released. This figure has held below the critical 50 level – signaling contraction – during 5 of the past 7 survey periods, and unfortunately for dollar bulls, ISM services is anticipated to hold at 49.5 in August. The key to the currency’s reaction, though, is where the index stands relative to 50, as a push above there could trigger another rally for the greenback while a sharper contraction could spark dollar sell-offs. The other factor to watch is the employment component, as this tends to be a good leading indicator for Friday’s US non-farm payrolls. My fundamental bias for the US dollar through the end of the week: bearish. I do think the ECB and BOE rate decisions bear watching though. As we saw last month, ECB President Trichet’s comments can spark wild volatility market-wide.

British Pound Awaits BOE Rate Decision – Will They Consider Cutting Rates?
The British pound ended the day slightly lower versus the US dollar, and is down almost 2.5 percent from last week’s close. There was no data on hand today, but bearish sentiment on the currency is proving hard to shake, especially since Credit Suisse overnight index swaps are pricing in almost 100bps worth of cuts within the next 12 months. While the Bank of England is widely anticipated to leave rates unchanged at 5.00 percent on Thursday, I think there is some potential for a surprise rate cut. Commentary by Bank of England policy makers and government officials suggests that many are truly worried that the UK is headed for recession, and it’ll be worth watching to see of MPC member David Blanchflower will remain the lone dove of the group, or if the sharp economic slowdown will convince others to vote for a reduction in the Bank Rate as well. Unfortunately, if the central bank leaves rates unchanged, no policy statement will be released and traders will have to await the release of the minutes from the meeting on September 17 for a glimpse at the vote count.

Commodity Dollars Ready to Rebound? Bank of Canada Leaves Rates at 3.00%
From a technical perspective, it appears that commodity currencies like the Canadian dollar, Australian dollar, and New Zealand dollar may all be due to recoup some of their massive losses. Indeed, AUD/USD has run into trendline support going back to 3/2006, NZD/USD has held up above a rising trendline going back to late 2001, and USD/CAD has backed off from falling trendline resistance going back to mid-2004. Likewise, the plunge in commodities may be slowing down, as WTI crude oil futures were down as much as $2.50 on Wednesday, but ended the day down $0.35 at $109.38/bbl, right near the 200 SMA. From a fundamental perspective, the only real contributing forex market-mover was the Bank of Canada’s rate decision. While they did not change the Bank Rate from its current level of 3.00 percent, the Bank’s Governing Council said that rates are "appropriately accommodative," suggesting that they had no intention of even considering reducing rates. This runs counter to Credit Suisse overnight index swaps, which are pricing in approximately 50bps worth of cuts within the next 12 months, and explains why the Canadian dollar rallied on the news. In the next 24 hours, there is little event risk on hand for the Loonie, Aussie, and Kiwi, but given technical factors my bias is for the commodity dollars to recover further through the end of the week.

Japanese Yen Strong Against High Yielders As Carry Trades Sell-Off
We know that risk sentiment remains the primary driver of the Japanese yen because political turmoil has recently emerged and Japanese economic data has been absolutely abysmal, but yet the low-yielding currency has remained strong against its foreign counterparts. This remains the case, as the currency gained across the majors, but especially so against the high-yielding Kiwi and Aussie dollars. What gives? With global credit risks remaining high and equity markets susceptible to sharp decline, traders aren’t rushing to pile into the carry trade quite yet. My bias for the Japanese yen going forward versus most of the majors: bullish.

In Consolidation Mode Until Friday

US Dollar: In Consolidation Mode Until Friday
The US Dollar was generally stronger across the majors on Wednesday, though economic data had little to do with the gains and the currency continues to simply consolidate.

Though there are US indicators scheduled for release on Thursday (Philly Fed, leading indicators), neither tends to be incredibly market-moving and as a result, the US dollar may not make any major directional moves until Friday. Why Friday? One word: Bernanke. On Friday at 10:00 EDT, Federal Reserve Chairman Ben Bernanke will speak on financial stability at the Kansas City Fed’s annual symposium in Jackson Hole, WY. His commentary tends to ignite major volatility for not only the greenback, but also for US Treasury and equity markets (and thus, the Japanese yen crosses). Given the uncertainty surrounding the health of US financial institutions, commentary on the financial markets will be watched closely and bearish sentiment by Mr. Bernanke could weigh heavily on risk-appetite. On the other hand, if Mr. Bernanke signals optimism that the US economy and financial sector can weather the storm, the US Dollar and risky assets, in general, could gain.

British Pound Drops On BOE Minutes - Buying Opportunity? Maybe Not.
The British pound tumbled lower for a test of 1.8550 this morning on the release of the minutes from the Bank of England’s most recent policy meeting. The BOE meeting minutes revealed a 7-1-1 vote to leave rates steady in August at 5.00 percent, with one dissent by Tim Besley in favor of a 25bp hike and one dissent by the ever-dovish David Blanchflower in favor of a 25bp cut. This was the same vote count that we saw in July, which helped to limit the impact of the release on the British pound. Looking at the details of the minutes, the Committee continues to harp upon inflation, and with CPI well above their 2 percent target at 4.4 percent this is not entirely surprising. However, they are clearly concerned about growth as well, and with the Committee saying that their main questions were “the likely degree of persistence in inflation and how much spare capacity would be needed to offset that persistence,” it appears the BOE will seek to leave rates steady, rather than raise rates.

Indeed, with the 5 percent Bank Rate already weighing on economic expansion, they are hoping that the slowdown will be enough to bring price pressures down on its own, and until CPI starts to fall lower, the BOE is unlikely to make monetary policy more accommodative. While overnight index swaps may be pricing in over 75bps worth of rate cuts within the next 12 months, these moves may not occur until 2009. As a result, there are still opportunities for the British pound to gain, but with the latest FXCM SSI numbers showing that traders are buying up GBP/USD (long positions are up 15.5 percent from yesterday), the contrarian indicator suggests the pair could continue lower. Furthermore, upcoming event risk is anticipated to work in favor of GBP/USD bears since UK retail sales for the month of July are forecasted to slump 0.2 percent, dragging the annual rate down to a more than 2-year low of 1.8 percent. As I mentioned in my forex forecast for the top 5 indicators of the week, the data would be in line with the British Retail Consortium’s (BRC) July survey, which indicated that consumers tightened their purse strings and led same-store sales to tumble 0.9 percent from last year. Furthermore, labor market conditions have started to deteriorate as jobless claims have risen during the past six months, suggesting that consumption growth peaked long ago.

US Dollar Finally Falls From Nearly 8-Month Highs

US Dollar Finally Falls From Nearly 8-Month Highs
The US dollar tumbled across the majors, especially against high-yielders, as the currency remains vastly overbought. Indeed, we’ve been saying for days that the extensive dollar rally was due for a retracement, and the move finally came despite the release of mixed economic data. First, the US producer price index jumped 1.2 percent in July, pushing the annual rate to a 26-year high of 9.8 percent. As usual, the bulk of this increase was due to energy and commodity costs, as the core measure rose 0.7 percent during the month to bring the annual rate up to 3.5 percent. However, the dollar’s reaction was relatively muted, as the markets are already well aware that inflation is a problem in the US, given the jump in US CPI last week to a 17-year high of 5.6 percent. Furthermore, recent commentary by Federal Reserve officials suggests that the central bank will opt to leave rates steady this year in an effort to allow an economic slowdown to cool price pressures.

Meanwhile, US housing starts fell more than expected to a 17-year low of 965K in July while applications for building permits slumped to 937K from 1138K. As we saw in Monday’s release of the NAHB index, homebuilder sentiment has been particularly pessimistic as they are faced with the reality of excess home inventories and weakening demand. Overall, it is clear that the housing recession is far from over, and with home values likely to continue falling the outlook for financial institutions remains bleak.

Euro Bounces as Investor Outlooks Improve
The Euro managed to recover from 6 month lows on Tuesday as the German ZEW survey of investor sentiment rose more than expected to -55.5 in August from a record low of -63.9.

It appears that falling oil prices and a weakening euro helped to boost confidence in the outlook, which is similar to what we saw in the latest US consumer confidence reports. However, investors remain concerned about current conditions, as this component was worse than expected at -9.2, down from 17. Nevertheless, the move in EUR/USD likely had more to do with the fact that the pair was simply very oversold, and with forex positioning showing that traders are turning increasingly bearish on the pair, the contrarian indicator suggests that the pair should rise further.

British Pound Awaits BOE Meeting Minutes
The British pound has done little but consolidate above nearly 2-year lows, but if the release of the Bank of England’s meeting minutes from August are anywhere near as market-moving as the BOE Quarterly Inflation Report, GBP/USD may not hold near current levels for long.

During the July meeting, the minutes revealed that there was a 7-1-1 vote to leave rates at 5.00 percent, with one dissent in favor of a 25bp hike and one in favor of a 25bp cut. With indicators of growth continuing to deteriorate and inflation figures reflecting rising prices, there is potential for there to be yet another split vote this time around, and such a result is unlikely to have a big impact on GBP/USD. However, given the revised GDP and CPI projections in the Quarterly Inflation Report, I think there’s some potential for additional Monetary Policy Committee members to have voted for a rate cut. Indeed, a 6-2-1 or 7-2 vote count could weigh heavily on the British pound on Wednesday morning, but if there is sufficiently hawkish rhetoric contained within the minutes, the UK currency should hold above the recent lows.

Commodity Dollars Gain On Oil, Gold - Canadian Dollar Faces Retail Sales
The Australian dollar, New Zealand dollar, and Canadian dollar all gained on Tuesday thanks to a bounce in crude oil and gold futures, along with a broad decline in the US dollar.

The only release of note was the minutes from the Reserve Bank of Australia’s August meeting, which supported market expectations for 100bps worth of rate cuts within the next 12 months, according to Credit Suisse overnight index swaps, as they said that slowing demand gave them increasing scope “to move towards a less restrictive setting of monetary policy.” However, don’t expect a change in rates anytime soon, since the RBA still judges that inflation risks remain high. Indeed, until consumer price indicators start to fall closet to target in late 2008 or 2009, the central bank is likely to leave rates steady at 7.25 percent. Looking ahead to Wednesday, Canadian retail sales will be released. As I mentioned in my outlook for the 5 key events this week, wholesale sales tend to be a good leading indicator for the retail figure. Given the stronger-than-expected 2.0 percent reading we saw this morning, retail sales could be a better than forecasts as well, which should help the Canadian dollar rise on Wednesday.

US Dollar Breaks Through Key Resistance As US CPI Hits 17-Year High

US Dollar Breaks Through Key Resistance As US CPI Hits 17-Year High – Rally Likely to Continue
The US Dollar index finally managed to rise above critical resistance from a falling trendline connecting the late 2005 – 2007 highs, indicating that the currency’s rally is not over quite yet. However, according to the latest forex positioning figures, traders are growing less bearish on the greenback, and as a contrarian indicator, this means the currency is likely to consolidate near current levels. What happened to trigger the jump in the dollar? US CPI hit a 17-year high of 5.6 percent in July, which was significantly higher than expected and was driven by food and energy cost gains. Meanwhile, core CPI edged up to a 17-month high of 2.5 percent. However, the greenback’s reaction was delayed, and we’ve actually seen that interest rate expectations – as measured by Credit Suisse overnight index swaps – haven’t changed very much, as they are still pricing in 75bps worth of rate hikes within the next 12 months. Indeed, the markets are already well aware that downside growth risks and upside inflation risks plague the US economy, but given the persistent instability in the financial markets, the Federal Reserve really has little room for maneuver and will likely leave rates unchanged at 2.00 percent until 2009. Indeed, financial institutions are not out of the woods yet, as the central bank continues to hold auctions at least twice a month for credit through its Term Auction Facility (TAF), which was started back on December 12, 2007, and demand is consistently higher than the offered amount. In fact, the latest auctions for $25 billion in 84-day credit and $50 billion in 28-day credit saw over $130 billion in propositions submitted. Given the fact that the program is still running after 8 months, liquidity has obviously not been fully restored and with the credit crunch still lingering, the Federal Reserve has no room to raise rates anytime soon.

Euro Drops Below 2007 Highs As Q2 GDP Contracts, CPI Holds Steady
The Euro remained heavy on Thursday as Euro-zone GDP contracted 0.2 percent in Q2, dragging the annual rate to a more than 3-year low of 1.5 percent. This is only the initial estimate of the reading so a breakdown is not available, but the latest PMI reports for the services and manufacturing sectors have signaling a contraction in business activity, signaling waning domestic and foreign demand. Meanwhile, Euro-zone CPI unexpectedly held steady at an annual rate of 4.0 percent. While this is still well above the European Central Bank’s 2.0 percent target, the fact the index didn’t accelerate faster was enough to lead the markets to become more aggressive in pricing in a rate cut by the central bank within the next 12 months. This shift in sentiment, where traders are expecting rate cuts by the ECB and rate hikes by the Fed, puts the odds in favor of additional EUR/USD losses in coming weeks.

British Pound Consolidates Huge Losses as Markets Price in 75bps Worth of Rate Cuts
There were no economic releases on hand for the British Pound on Thursday, but lingering sentiment from Wednesday’s BOE Quarterly Inflation Report was enough to continue weighing on the currency. Indeed, the central bank offered a bleak picture of UK economic conditions, as they revised their growth projections sharply lower for 2008 – 2009 and even said that GDP could be negative for one or two quarters. Meanwhile, the markets have shifted to price in more aggressive rate cuts by the BOE over the next 12 months, as Credit Suisse overnight index swaps are now pricing in almost 75bps worth of cuts compared to 50bps just a few days ago. The odds are against the BOE, but we believe that the central bank will not move to cut rates until 2009 as they try to allow the UK’s economic slowdown to bring down inflation pressures. In the near-term, GBP/USD is likely to continue consolidating above the recent lows at 1.8650, but I still believe that the pair will ultimately move down for a test of 1.85.

Commodity Dollars Struggles To Hold Onto Latest Gains
The Australian Dollar, New Zealand Dollar, and Canadian Dollar all struggled to hold on to Wednesday’s gains amidst choppy trading, as commodities like gold and oil ended the day lower. However, gold has now fallen for 9 of the past 10 trading days, suggesting that a bounce may be in store for the metal and commodity dollars alike. Meanwhile, New Zealand retail sales were better than expected in June, as the index jumped 0.9 percent. However, the Q2 reading that excludes inflation fell 1.5 percent, marking the second consecutive quarter of contraction. Nevertheless, in the longer-term, there is still significant downside risk for Aussie, Kiwi, and the Loonie. Consequently, rallies in these currencies should be seen as selling opportunities.

Japanese Yen: Still Mixed Across the Majors, Upside Risk Remains for the Low-Yielder
The Japanese Yen ended the day lower against the greenback and British Pound but rallied against the rest of the majors, as the markets remain jittery. Indeed, the DJIA saw extremely choppy trade as the index opened lower, but subsequently ended the day nearly 100 points higher. However, as we mentioned above, the financial markets remain very unstable, and traders should continue to keep an eye on technical levels and risk sentiment, as the Japanese yen tends to trade based on these factors rather than fundamentals.

US Dollar Rally Stalls on Dovish Fed Commentary

US Dollar Rally Stalls on Dovish Fed Commentary, Ahead of Advance Retail Sales
The US dollar rally stalled out against the Euro, Japanese yen, and Canadian dollar on Tuesday amidst somewhat-dovish commentary by Minneapolis Fed President Gary Stern. During an interview with CNBC, Mr. Stern said that “some of the concerns about inflation and some inflation expectations seem to have diminished,” which removes much of the logic behind speculation of rate increases by the Federal Reserve. In fact, overnight index swaps are still pricing in 86bps worth of hikes within the next 12 months, but data releases on Wednesday and Thursday may shake these forecasts up. Advance Retail Sales are expected to slip 0.1 percent in July and the index that excludes auto sales is forecasted to increase 0.5 percent, as consumers continue to spend, albeit at a slower pace. However, there is downside risk for this report, as we also have to consider the fact that average gasoline prices fell throughout the latter part of July from over $4/gallon. In recent months, the surge in gas prices alone has helped lift the overall index since it is not adjusted for inflation. Thus, recent declines could actually weigh on the headline reading and pushed Advance Retail Sales deep into negative territory for the first time in five months. Meanwhile, US import price growth is anticipated to slow thanks to the appreciation of the greenback, which may weigh on the US dollar slightly. From a technical perspective, the US dollar index is still holding below a falling trendline which connects the late 2005 – 2007 highs, adding to evidence that the greenback could ease lower on Wednesday. However, that is not to say that the currency won’t be able to gain against some majors, as GBP/USD broke below critical support on Tuesday at the 200 SMA at 0.9022, signaling the pair is likely to continue falling to ultimately test 1.85.

Euro Successfully Holds Above 2007 Highs
Despite an early-morning plunge to 1.4815, the Euro managed to recover during Tuesday’s US trading session and as of the NY close, EUR/USD was successfully holding above the 2007 highs near 1.4880/1.4900. However, overnight index swaps are still pricing in over 25bps worth of rate cuts by the European Central Bank and over 75bps worth of rate hikes by the Federal Reserve within the next 12 months. As long as the markets are betting on such interest rate probabilities, EUR/USD will have difficulty accumulating substantial gains. Event risk for the pair is contingent upon the previously mentioned US data on Wednesday, but caution should be paid to Thursday’s Euro-zone releases as GDP and CPI have the potential to shake the Euro up significantly. Until then, my fundamental bias for the Euro on Wednesday is bullish. Looking at the daily EUR/USD charts, the long lower wick on Tuesday’s candle suggests the pair may have hit a short-term bottom.

British Pound Breaks Key Support, More Declines May Be In Store
The British pound finally managed to break below the 200 SMA on the weekly charts at 1.9022, a level which the pair has held above since June 2002. Perhaps the most surprising part of this is that UK CPI was stronger than expected this morning, as the annual rate accelerated to 4.4 percent. This is not only the highest level since comparable records began in 1997, but is also well above the Bank of England’s 2 percent target and 3 percent upper limit. The data puts the BOE Monetary Policy Committee in an even worse position, as robust price pressures calls attention away from widespread indications of a sharp UK economic slowdown. Last month, the majority of the MPC members voted to leave rates steady, but there was one vote in favor of a 25bp hike and one in favor of a 25bp cut. Currently, overnight index swaps are pricing in 44bps worth of cuts within the next 12 months, down from 52bps last Wednesday. Clearly, these UK CPI numbers haven’t had an extreme impact on rate expectations, but Wednesday’s release of the BOE’s Quarterly Inflation Report might. This has great market-moving potential as it will serve as a more timely view of the MPC’s bias (the August 7 meeting minutes will not be released until August 20). Everyone knows that inflation is a problem in the UK, but if the Bank’s GDP projections are revised down, this news would support the case for a British pound decline toward 1.8500.

Australian Dollar, New Zealand Dollar Plunge As Demand For Yield Wanes
The Australian dollar and New Zealand dollar both plunged during Tuesday’s trading session as high-yielding currencies were sold off sharply. While the correlation between carry trades and the DJIA is not as strong as it once was, according to our latest forex correlations report, the price action throughout the financial markets was indicative of risk aversion and deleveraging. Indeed, the DJIA plummeted 1.19 percent, demand for Treasuries rose, leading yields lower, commodities like gold and oil fell, while the Japanese yen rallied across the majors. On the other hand, the Canadian dollar snapped its losing streak following the release of Canadian trade figures on Tuesday morning. In fact, the Canadian international merchandise trade balance rose to C$5.8 billion from C$5.2 billion as US demand for exports jumped 5.3 percent in June. The data suggests that the export industry may help support Canadian expansion, but since this is such a lagging indicator, it may not be worth putting too much stock in this sort of sentiment. There are no major releases due for the commodity dollars overnight, though a jump in the Australian Wage Cost Index for Q2 could help to provide the beleaguered Aussie with a boost. Nevertheless, the trend for AUD/USD and NZD/USD remains bearish.

Japanese Yen Rockets As Risk Aversion Makes a Comeback
As we mentioned in our discussion of the Australian dollar and New Zealand dollar, risk aversion returned on Tuesday, weighing heavily on high-yielding currencies and rewarding the low-yielding Japanese yen. In fact, the Japanese yen gained a whopping 1.89 percent against the Aussie, 1.45 percent against the British pound, and 1.2 percent against the Kiwi. That said, there is still downside potential for the Japanese yen crosses, including USD/JPY, this week.

Euro Pummeled as ECB Turns Attention to Downside Economic Risks

US Dollar: Bullish Break May Signal Additional Gains To Come
The US dollar rally continued on Thursday on speculation of the future direction of interest rates in the US, Euro-zone and UK. Indeed, the markets are now betting that the European Central Bank and Bank of England are likely to make their next policy move a rate cut. While we believe the Federal Reserve will not change rates before year-end, the simple shift in rate bets for the ECB and BOE are enough to underpin US dollar strength in light of the FOMC’s notation of significant upside inflation risks on Tuesday. From a technical perspective, we’ve seen EUR/USD and GBP/USD run into important support levels, but on the other hand, the Dollar Index has broken above the June 13 high of 74.30, suggesting the greenback’s rally on Thursday marks an important bullish break. That said, price action does not move in a straight line, and as a result I think the US dollar is more likely to consolidate its recent gains during Friday’s trading session, particularly since no key US data is on the calendar until next week.

Euro Pummeled as ECB Turns Attention to Downside Economic Risks
Despite an initial surge higher, the Euro tanked following the release of the European Central Bank’s rate decision. Indeed, the ECB left rates steady at 4.25 percent, but it was ECB President Jean-Claude Trichet who, as usual, proved to be more market-moving. Mr. Trichet said that recent economic data pointed toward "a weakening of real GDP growth in mid-2008" following strong growth during Q1, and with Euro-zone Q2 GDP scheduled to be released on August 14, there are concerns that the economy actually contracted. Meanwhile, the ECB remains particularly hawkish on inflation, saying that CPI would remain above 2 percent for "some time" and that recent data supported the latest rate hike in July. Since price stability is the ECB's primary mandate, the central bank will have limited ability to completely brush off the inflation data on hand in order to make monetary policy more accommodative due to an economic slowdown. Nevertheless, the markets have taken the bearish notes on growth to heart, as overnight index swaps are now pricing in 25bps worth of rate cuts within the next year, which is clearly to the detriment of the Euro. However, market expectations change and so can this speculation about interest rate reductions. Two key events that I think will be the most important for this include Euro-zone Q2 GDP next week and the release of the ECB’s growth and inflation forecasts in September. From a technical standpoint, EUR/USD is currently testing the 3/11, 5/8, and 6/12 lows near 1.5300. Given the extent of the recent declines (around 700 pips from the 7/15 record and over 200 pips since the start of the week), my bias is that EUR/USD should consolidate above 1.5300 in coming days, especially since there is no major European data scheduled for release on Friday. However, a break below this point would be indicative of sharper declines toward the 200 SMA at 1.5220 and the 50% fib of 1.4309 – 1.6036 at 1.5175.

British Pound Tumbles Despite BOE Decision To Leave Rates Steady – Why?
Looking at the British pound versus the US dollar on Thursday, one would think the Bank of England had surprisingly cut rates. However, this was not the case as the BOE left rates steady at 5.00 percent and did not issue a monetary policy statement, as expected. In fact, GBP/USD initially edged higher following the announcement, but it was a bout of US dollar strength following commentary by ECB President Trichet that really sparked the move. While we don’t have anything new to go on following the BOE meeting, overnight index swaps now show that the market anticipate 50bps worth of cuts within the next 12 months, and for good reason. While CPI remains well above the Monetary Policy Committee’s 2.0 percent target at 3.8 percent, business activity in the manufacturing, services, and construction sectors are all contracting, putting the UK economy at risk of recession. As a result, downside risks loom for the UK’s Bank Rate, and thus, the British pound. Nevertheless, with no UK data scheduled to be released on Friday, GBP/USD may simply consolidate above trendline support at 1.9400 for now, though a break below that level should target the March 2007 lows of 1.9185.

Commodity Dollars Down As Traders Continue To Sell High-Yielders
Weakness in commodities, risk aversion, and broad US dollar buying has weighed heavily on the high-yielding commodity dollars, including AUD/USD and NZD/USD. The Canadian dollar has not been immune either as the currency fell to 11-year lows versus the greenback on Thursday. Furthermore, declines for the Loonie may not be over yet as Canadian labor market data will be released. The Statistics Canada release of the net employment change is forecasted to rise by 5,000 while the unemployment rate is anticipated to hold at 6.2 percent. However, the employment component of the latest Ivey PMI report fell below 50 for the first time since December, indicating contraction. The last time this happened, the government release of the net employment change was surprisingly weak, and I think there is some potential for a similar disappointment on Friday. As a result, my fundamental bias for the Canadian dollar on Friday is bearish.

Japanese Yen Surges On Return To Risk Aversion
The Japanese yen rose across the majors on Thursday, though the low-yielder hardly budged versus the greenback, as traders sell high-yielding and risky assets. In fact, the same factors we mentioned above that are weighing on the commodity dollars are doing the exact opposite for the Japanese yen, and we’re seeing that the correlation between EUR/JPY and the DJIA is a bit better. That said, all of these assets are still essentially range trading and consolidating the larger moves from earlier in the year. **Something I’ve failed to note in recent days is that USD/JPY is the Japanese yen cross I watch most frequently, and thus, typically refer to in my analysis. However, there’s a clear divergence in trading of the yen versus the US dollar compared to the rest of the majors, and as a result, I will be sure to clarify my views going forward.

Pound and Euro Forecast

Today, the Bank of England and the European Central Bank will each announce their monetary policy decisions. Expectations are for both banks to leave rates steady, but given the steep declines we’ve seen in the Euro and British pound recently, even decisions in line with expectations could lead the currencies to rebound. The question is: will these moves be in the form of significant rallies, or will the gains be short-lived?

Bank of England – Risks Tilted Toward Additional Rate Cuts This Year

Bias for This Meeting: No Change
The Bank of England is expected to leave rates steady on Thursday at 5.00 percent – the lowest since December 2006 – for the fourth consecutive month. Indeed, all of the 60 economists polled by Bloomberg News anticipate such a decision. The rate announcement will come at 7:00 EDT but since the Monetary Policy Committee is anticipated to leave rates unchanged, they are unlikely to issue a monetary policy statement which should leave the market’s reaction to the news somewhat muted.

What are the fundamental factors that the MPC will be taking into account? Inflation pressures in the UK have built up significantly on the back of rocketing commodity prices, as CPI jumped to an annualized pace of 3.8 percent in June. Furthermore, the latest BRC Shop Price numbers for July suggest that consumer price growth accelerated even more. Rising costs are weighing heavily on consumer sentiment, especially as jobless claims jump and home prices continue to freefall. This has translated into lackluster retail sales, which plunged 3.9 percent in June alone, and a contraction in service sector business activity for the third consecutive month. Likewise, the July PMI reading for the manufacturing sector also reflected contraction for the third month in a row, while output has fallen negative in five of the past seven months. The persistent gains in measures of consumer prices should keep the Bank of England’s MPC concerned about inflation risks, but perpetual doves like David Blanchflower are sure to focus more on potential for a UK recession.

How will the Markets Respond to the News? Currently, overnight index swaps are pricing in almost 50bps worth of rate cuts within the next 12 months, which is part of the reason why the British pound has taken such a heavy hit versus the US dollar in recent weeks. However, once traders see that the Bank of England has chosen to, in fact, leave the Bank Rate unchanged at this meeting, the markets may reduce those rate cut expectations. Thus, there is potential for GBP/USD to rise on Thursday. On the other hand, if the Bank of England unexpectedly decreases the Bank Rate to 4.75 percent, or surprisingly publishes a Monetary Policy Statement that focuses on dour credit conditions and downside risks to growth, speculation of additional rate cuts will surely mount and weigh heavily on the British pound. Nevertheless, the odds of this happening are very slim, and as a result, we hold a bullish bias for the British pound on Thursday.


European Central Bank – Will Mr. Trichet Finally Cool Down His Hawkish Rhetoric?

Bias for this Meeting: No Change
Like the Bank of England, the European Central Bank is widely expected to leave rates steady at 4.25 percent after hiking by 25bps in July. The rate announcement will come at 7:45 EDT, but the big show is at 8:30 EDT when ECB President Jean-Claude Trichet will give his monthly press conference. Will he remain hawkish, or focus more on the slowdown in the economies that compose the Euro-zone? Estimates for Euro-zone CPI in July jumped to a fresh 16-year high of 4.1 percent from 4.0 percent, which is well above the ECB’s 2 percent target as energy and food costs remain high. Furthermore, the Bank of Spain said last week that “upside risks for inflation in the Euro-zone are high.” As a result, there’s little doubt “price stability” will be the foremost concern for Mr. Trichet.

How will the Markets Respond to the News?
Where we see there being risk for the euro is in Mr. Trichet’s comments on growth. While he was fairly clear in stating that there were significant downside risks to growth during his monthly press conference in July, he maintained that growth was “moderate” and “ongoing.” However, conditions have deteriorated quite a bit since then, especially for consumers. In fact, the annual rate of Euro-zone retail sales growth fell to a record low of -3.1 percent in June, as the unemployment rate unexpectedly rose to 7.3 percent from 7.2 percent. Meanwhile, July PMI reports for both the services and manufacturing sectors signaled a contraction in business activity for the second months in a row. While this does not put the ECB at risk of cutting rates given the fact that they only have one primary mandate of maintaining price stability, Mr. Trichet may be more inclined to admit the deterioration in the economy during his 8:30 EDT press conference on Thursday.

Currently, overnight index swaps are pricing in a very small chance of a rate cut within the next 12 months, but the recent moves in EUR/USD have more to do with the fact that traders are also pricing in rate increases by the Federal Reserve during the same period. Yet, if Mr. Trichet’s commentary is hawkish enough to convince the markets that they have no intention of reducing rates anytime soon, the euro is likely to subsequently gain. However, it may take particularly strong words to ignite a significant rally for the currency, such as references to the ECB being in a state of “heightened alertness.” On the flip side, if Mr. Trichet focuses more on monetary policy being appropriately accommodative, suggests that inflation pressures could ease in coming months, or sounds significantly more bearish on the Euro-zone economy, EUR/USD could continue to fall. Our bias for Thursday? EUR/USD could rally on Mr. Trichet’s comments, but the gains may be short-lived.

US Dollar Bulls Stay In The Game As Fed Rate Hike Speculation Goes Little Changed

US Dollar Bulls Stay In The Game As Fed Rate Hike Speculation Goes Little Changed
The US dollar gained across the majors on Wednesday as the FOMC’s policy statement failed to quell speculation of 75bps worth of rate hikes over the next 12 months. Yesterday we said that the FOMC “essentially said that they would leave rates steady at 2.00 percent going forward, as they noted downside risks to growth and upside risks to inflation.” However, it appears that today, the markets took the line noting that upside inflation risks are of “significant concern” to the FOMC to heart. Regardless, we still do not believe that the Committee is willing to ignore slowing growth in order to fight inflation and inflation expectations. While the recent bounce in the US stock markets has left many optimistic, financial institutions are still not in the clear. The latest example: Morgan Stanley reportedly informed thousands of customers that they would not be able to withdraw money from their home equity lines of credit (HELOC). Is the credit crunch over? These customers would probably tell you “no.” That said, many of these clients’ properties had declined in value, making the move by Morgan Stanley prudent from a risk management perspective. Yet, it is still a clear sign that the days of free-wheeling lending is over, which will make paying bills increasingly difficult for consumers that are used to regularly drawing off of credit cards and home equity withdrawals. Looking ahead to Thursday, US pending home sales are anticipated to fall 1.0 percent in June, as demand for properties continues to wane. However, US dollar price action may have more to do with the outcome of the European Central Bank and Bank of England rate decisions, and as a result, my fundamental bias for the greenback on Thursday morning is bearish.

Euro: How Will The ECB Rate Decision Impact EUR/USD?
The euro continued its descent on Wednesday, getting a little help from the release of German factory orders, which plunged 2.9 percent during the month of June. With the European Central Bank announcing their rate decision on Thursday morning, weak Euro-zone data has had a bigger impact on the currency. While indicators have generally signaling that the region’s economy is slowing quite a bit, it will not be enough to lead the ECB to consider cutting rates as they are widely expected to leave rates steady at 4.25 percent after hiking by 25bps in July. The rate announcement will come at 7:45 EDT, but the big show is at 8:30 EDT when ECB President Jean-Claude Trichet will give his monthly press conference. Currently, overnight index swaps are pricing in a very small chance of a rate cut within the next 12 months, but the recent moves in EUR/USD have more to do with the fact that traders are also pricing in rate increases by the Federal Reserve during the same period. Yet, if Mr. Trichet’s commentary is hawkish enough to convince the markets that they have no intention of reducing rates anytime soon, the euro is likely to subsequently gain. However, it may take particularly strong words to ignite a significant rally for the currency, such as references to the ECB being in a state of “heightened alertness.” On the flip side, if Mr. Trichet focuses more on monetary policy being appropriately accommodative, suggests that inflation pressures could ease in coming months, or sounds significantly more bearish on the Euro-zone economy, EUR/USD could continue to fall. My bias for Thursday: EUR/USD could rally on Mr. Trichet’s comments, but the gains may be short-lived. According to FXCM SSI, forex traders are net long EUR/USD, and since the index is a contrarian indicator, the trend for the pair likely remains bearish.

British Pound: Can the BOE Rate Decision Prevent A Break Below 1.94?
The British pound plummeted nearly 100 points on Wednesday as traders continue to bet on nearly 50bps worth of rate cuts within the next year, according to overnight index swaps. However, none of those cuts are anticipated to come on Thursday when the Bank of England meets. In fact, the central bank is widely expected to leave rates steady at 5.00 percent this time around, but since the BOE does not typically issue a monetary policy statement when they do not change the Bank Rate, this could end up being a non-event. On the other hand, as we mentioned in our forex forecast for the BOE rate decision, since the British pound has fallen so sharply in recent weeks, the mere lack of a rate cut could be enough to provide the currency with a boost. My fundamental bias for the British pound on Thursday: bullish.

Canadian Dollar Gets Brief Boost From Ivey PMI, Watch Out For Aussie, NZ Employment Data
Declines in gold and oil prices continued to weigh on the Australian, Canadian, and the New Zealand dollar, with the USD/CAD pair rising for the third consecutive day to hold well above former resistance at 1.0450. The release of Canadian Ivey PMI provided a brief boost to the Canadian dollar, as the index fell less than expected to 65.5 in July from a previous reading of 69.6 in June. Looking deeper into the report, the employment component of the index fell to 46.3 from 58.2, hinting that labor market conditions are slowly deteriorating as firms grapple with higher raw material costs and slowing demand. Looking ahead, Australian labor data will be the main event risk for the Aussie over the next 24 hours, and may spur downside risks for the currency as the unemployment rate is anticipated to edge higher to 4.3 percent from 4.2 percent. Likewise, the New Zealand unemployment rate for Q2 is forecasted to rise to 3.8 percent from 3.6 percent, which could add to speculation that the RBNZ will cut rates again at their next policy meeting. My fundamental bias for the commodity dollars overnight: bearish.

Japanese Yen Down Across the Majors As USD/JPY Breaks Out
The Japanese yen fell versus the majors with the help of a surge in USD/JPY that marked the end of a long period of consolidation for the pair. Indeed, USD/JPY had been holding within a rising wedge formation for weeks, and finally managed to break above the February and June highs of 108.60. Meanwhile, US equity markets have managed to hold on to their recent gains, so does this mean that the carry trade is back? Risks for global markets remain high, but it appears that for now, risk aversion has faded. Indeed, traders can’t remain bearish forever. That said, I think this is a development worth watching and trading, but mostly because it is likely to eventually provide an opportunity within the next few months to sell carry/risky assets. Looking ahead, Japanese machine orders for the month of June are forecasted to fall 9.5 percent, which would be inline with recent comments by government officials saying that the growth is “deteriorating,” and that there is “a high possibility the economy has entered a recession.” My fundamental bias for the Japanese yen: bearish…for now.

Emerging Markets – South African Rand Down 0.7% as Strikes Shut Down Gold Mines
The South African Rand tumbled 0.7 percent versus the US dollar as a strike by the Congress of South African Trade Unions protesting high energy prices shut down gold mines in the export-dependent country. Meanwhile, the Mexican Peso and Turkish Lira edged lower amidst broad US dollar strength. There was no data on hand today, but tomorrow, South African manufacturing output is anticipated to improve, while Mexican consumer prices are forecasted to rise further. My fundamental bias for the Rand and Peso on Thursday: bullish.

Will the Bulls Bail Out as FOMC Leaves Rates at 2.00%

US Dollar: Will the Bulls Bail Out as FOMC Leaves Rates at 2.00%, Signals Neutral Stance Going Forward?
The Federal Reserve left rates unchanged at 2.00 percent – as expected – but as usual, it was the FOMC’s policy statement that made all the difference for the US dollar. The Committee essentially said that they would leave rates steady at 2.00 percent going forward, as they noted downside risks to growth and upside risks to inflation. Furthermore, the statement said that “the substantial easing of monetary policy, combined with ongoing measures to foster market liquidity should help to promote moderate economic growth.” With the FOMC shying away from their hawkish bias, fed fund futures are now only pricing in a 25.8 percent chance of a 25bp hike in September, down from 30.2 percent yesterday. This is why the greenback edged back versus many of the majors, though the currency has struggled to move against the euro. Indeed, we tend to see that when it comes to FOMC rate decisions and policy statements, the underlying sentiment does not always feed through until the next day. Meanwhile, business activity in the non-manufacturing sector, which composes a large majority of US GDP, contracted for the second consecutive month in July according to the latest ISM survey. However, the index did manage to rise slightly to a reading of 49.5 from 48.2 thanks to a jump in the employment component to 47.1 from 43.8. Nevertheless, this still indicates worsening labor market conditions. My fundamental bias for the US dollar on Wednesday: bearish. Overall, the odds are becoming stacked against US dollar bulls given these recent developments and there are no major economic releases scheduled tomorrow to help counter this sentiment.

Euro Struggles Under Weight of Weak Euro-zone Retail Sales – Chance for Recovery Tomorrow
Economic indicators out of the Euro-zone continue to disappoint, as retail sales dropped 0.6 percent during the month of June, dragging the annual rate of growth down to a worse-than-expected -3.1 percent. Likewise, Euro-zone services PMI was confirmed at a reading of 48.3 in July, down from 49.1, which marks not only the second straight month of contraction but also a five year low. While ECB President Jean-Claude Trichet was fairly clear in stating that there were significant downside risks to growth during his monthly press conference in July, when the central bank hiked rates to 4.25 percent, he maintained that growth was “moderate” and “ongoing.” However, given these broad indications of slowing expansion, Mr. Trichet may be more inclined to admit the deterioration in the economy during his 8:30 EDT press conference on Thursday. Looking ahead to Wednesday, German factory orders are expected to rise slightly during the month of June, but the annual rate is anticipated to drop to -4.7 percent. While the PMI Manufacturing reports for Germany during that period did reflect growth during that month, the index has steadily fallen throughout the year, creating some downside risks for this release. However, the currency is more likely to continue trading as an anti-dollar vehicle throughout the day, and as a result, lingering sentiment from the FOMC’s policy statement may have a greater impact. My fundamental bias for the euro on Wednesday: bullish. Check out our Chief Strategist’s forecast for EUR/USD.

British Pound Manages to Hold Above Support At 1.9525
The British pound tumbled toward support at 1.9525 on Tuesday as UK industrial output contracted for the second month in a row and kept the annual rate down to -1.6 percent. While energy and mining producers are keeping pace, manufacturers are clearly suffering as output has fallen negative in five of the past seven months. Looking ahead to tomorrow morning, we’ll see the release of BRC Shop Prices for the month of July, but given persistent price growth in the UK economy, there’s some upside potential for this report. However, I think that like the euro, the British pound may trade more based on anti-dollar sentiment. As a result, my fundamental bias for the British pound on Wednesday is bullish.

Commodity Currencies: Aussie Gets Slammed as the Reserve Bank of Australia Turns Dovish
Broad declines in commodities like oil and gold led the Canadian, New Zealand, and Australian dollars lower, but AUD/USD took a particularly hard hit thanks to dovish sentiment by the Reserve Bank of Australia. Indeed, the RBA left rates steady as expected at 7.25 percent, but the Board’s policy statement was straightforward in suggesting that their next move would likely be a rate cut, as they said, “with demand slowing, the Board’s view is that scope to move towards a less restrictive stance of monetary policy in the period ahead is increasing.” While the most recent CPI numbers were surprisingly strong, indicators of economic growth in Australia have been broadly weak and the upcoming releases of the Home Loan Index and AiG’s Performance of Construction Index are anticipated to reflect the same thing. Likewise, Canada’s Ivey PMI report is forecasted to fall to a reading of 61.0 from 69.6 in July, pointing towards rapidly deteriorating business activity. My fundamental bias for the Australian and Canadian dollars on Wednesday: bearish. However, traders should beware of sharp moves in oil and gold, as this could shake up the currencies.

Japanese Yen Holds Despite Rally In Equities
The Japanese yen rose slightly versus the majority of the majors, but fell against the US dollar as indicators of risk sentiment – such as the CBOE’s VIX Index – declined while and US equity markets rallied. There was no pertinent economic data on hand for the currency, though it’s questionable if that matters as the yen is likely waiting for the next big shift in risk appetite market-wide. Like many markets, indexes like the DJIA may not fully respond to the Federal Reserve news until Wednesday’s trading session, and as a result, there’s still downside potential for USD/JPY. My fundamental bias for the Japanese yen: slightly bullish.

South African Rand Dragged Down By Gold, Mexican Peso, Turkish Lira Hold Strong
Emerging market currencies like the Mexican peso and Turkish Lira edged lower on Tuesday, but both remain relatively strong as the Banco de Mexico and the Central Bank of the Republic of Turkey (CBRT) both remain hawkish and likely to hike rates again before year-end as price pressures persist. The Mexican Peso was weighed down a bit as consumer confidence fell to a 7-year low of 88.4 from 90.7, as these increasing costs limit disposable income. Meanwhile, the South African Rand plummeted versus the greenback thanks to a 2.4 percent drop in gold futures to $886.10/oz. South Africa is extremely dependent upon exports for growth, and with prices falling, the value of those exports will only serve to erode the nation’s trade balance. Looking ahead to tomorrow, there is no data scheduled for release so traders should keep an eye on commodities and the US dollar for direction.

US Dollar Up Ahead of Fed Decision – What To Watch For

US Dollar Up Ahead of Fed Decision – What To Watch For
The US dollar gained across most of the majors today as US economic data surprised to the upside. Indeed, PCE Core accelerated to a six-month high of 2.3 percent, suggesting that price pressures are building throughout the US even excluding factors like food and energy costs. Meanwhile, personal income rose 0.1 percent while personal spending gained 0.6 percent, and though this was better than forecasts, both represent a post-rebate check disbursement slowdown in June. Looking ahead to tomorrow morning at 10:00 EDT, ISM non-manufacturing is anticipated to edge slightly higher to 48.7 from 48.2. The important thing to watch is to see if the index can rise above 50, signaling expansion in the sector. Will any of these factors change how the Federal Reserve decides to implement monetary policy? Unlikely. As Chief Strategist Antonio Sousa and I discussed in our FOMC Preview, the Fed will leave rates steady on Tuesday. The key to the direction of the US dollar tomorrow afternoon, though, has more to do with the FOMC’s bias in their policy statement. More than one dissent in favor of raising rates, or a clear focus on upside risks for inflation and inflation expectations could lead the US dollar to rally. On the other hand, a unanimous vote to leave rates at 2.00 percent, removal of the phrase noting higher inflation expectations, or any reference to re-emerging downside risks to growth should weigh heavily on the greenback. My fundamental bias for the US dollar on Tuesday: bullish. I anticipate the focus will be on inflation, but as we’ve seen in the past, this sentiment may not fully feed through until the day after. Thus, I would avoid trading the US dollar immediately after the news.

Euro Gains Versus British Pound, Yen as Producer Price Growth Hits Record High
The Euro-zone is experiencing no relief from rising prices, as the producer price index rocketed a record 8.0 percent in June from a year earlier. This was due primarily to 21.4 percent annualized jump in energy prices, and will do little to calm ECB President Jean-Claude Trichet’s hawkish bias. Though the ECB is anticipated to leave rates at 4.25 percent on Thursday morning at 7:30 EDT, we often find that Mr. Trichet’s commentary at 8:30 EDT is far more market-moving for the euro. Nevertheless, looking at more timely releases, Euro-zone retail sales are forecasted to have slumped 0.6 percent in the month of July. However, there is a risk that this figure will be even worse than predictions given the sharp drop in German retail sales during the same period. My fundamental bias for the euro on Tuesday: bearish. It’s worth noting that this release may only have a short-lived impact on the currency, especially when it comes to EUR/USD due to the US event risk on hand.

British Pound: Construction PMI Adds To UK Recession Risks
As if we needed additional evidence that the UK may be headed for recession, UK construction PMI hit yet another record low of 36.7 in July. Looking at a breakdown of the report, business activity and new orders appear to be grinding to a halt as the UK grapples with a housing sector collapse rivaling that of the US. On Tuesday, PMI for the services sector will hit the wires and is anticipated to hold below 50 and signal contraction for the third consecutive month. On the other hand, industrial production for the month of June is forecasted to rise a mild 0.1 percent, but given the weak results of the CBI Industrial Trends survey for the same period, there is potential for output to contract once again. My fundamental bias for the British pound on Tuesday: bearish. However, like the euro’s event risk, these UK releases may only have a brief impact on Cable.

Canadian Dollar: Weakest of the Commodity Currencies As Oil Tumbles
A nearly 3 percent drop in the price of crude oil futures to $121.41/bbl helped drive the Canadian dollar down on Monday, while the Australian dollar and New Zealand dollar struggled to make headway and ended the day little changed. Indeed, other commodities such as gold saw mild gains, helping to stem downward pressures on the Aussie. However, the currency faces heavy event risk overnight as the Reserve Bank of Australia will be meeting. The Board is expected to leave rates steady at 7.25 percent, but the market’s eyes will be on the RBA’s policy statement. The July statement was decidedly neutral, noting upside inflation risks and forecasts for more moderate domestic demand. Based on the economic indicators released since then, including a surge in Q2 CPI and drop in Q2 retail sales, this statement will likely be similar. My fundamental bias for the Australian dollar on Tuesday: bullish. The surprisingly strong inflation numbers could invoke more hawkish sentiment amongst the RBA’s Board members.

Japanese Yen Down Across the Majors As Risky Assets Consolidate
The Japanese yen slipped versus the majority of the majors, as indicators of risk sentiment – such as the CBOE’s VIX Index – and equity markets consolidate. There was no pertinent economic data on hand for the currency, though it’s questionable if that matters as the yen is likely waiting for the next big shift in risk appetite market-wide. Since Federal Reserve news can have a huge impact on US equity indexes, traders should look to Tuesday’s FOMC rate decision and policy statement, as this could be a major source of price action for the Japanese yen next week. My fundamental bias for the Japanese yen on Tuesday: mixed.

Mexican Peso Hits Nearly 6-Year High, Turkish Lira Holds Near 7-Year High
Emerging market currencies like the Mexican peso and Turkish Lira remain extremely strong as the Banco de Mexico and the Central Bank of the Republic of Turkey (CBRT) both remain hawkish and likely to hike rates again before year-end as price pressures remain strong. The latest inflation data was out of Turkey, as the annualized rate of consumer price growth surprisingly surged to a 4-year high of 12.1 percent. The news helped to keep Turkish lira bulls in the game after the currency gapped higher last week following news that the country’s Constitutional Court upheld the legality of the ruling AK Party in a narrow 7-6 vote. The country’s top prosecutor brought charges against the government of President Abdullah Gul and Prime Minister Recep Tayyip Ergodan, saying they violated Turkey’s strict secularism by introducing legislation such as removing a ban on the wearing of headscarves. Meanwhile, the South African Rand weakened as Naamsa Vehicle Sales held negative for the 16th consecutive month, pointing toward weakening domestic demand.

Could Non-Farm Payrolls Fall By 100K?

The US dollar has appreciated in recent weeks, as overnight index swaps signal that traders expect the Federal Reserve to raise rates by 75 basis points over the course of the next eight FOMC meetings. However, the next release of non-farm payrolls is expected to reveal job losses for the seventh consecutive month while the US unemployment rate is anticipated to hit a 4-year high of 5.6 percent. What are the chances that non-farm payrolls will prove to be even worse than forecasted, and more importantly, how will this impact the US dollar?

What is the Market Expecting for July Non-Farm Payrolls?

Change in Non-Farm Payrolls: -75k Forecast, -62k Previous
Unemployment Rate: 5.6% Forecast, 5.5% Previous
Change in Manufacturing Payrolls: -40k Forecast, -33k Previous
Average Hourly Earnings: 3.4% Forecast, 3.4% Previous
Average Weekly Hours: 33.7 Forecast, 33.7 Previous

Of the 79 economists polled by Bloomberg, the most optimistic forecast is by First Trust Advisors, which calls for a drop of 10k jobs. The most pessimistic is, once again, ING Financial Markets who is calling for job loss of -150k. All of these economists expect a negative print, but the range of estimates is extremely wide which means that traders should expect sharp volatility in the US dollar and the financial markets in general on the back of the non-farm payrolls release.

In order to determine the strength of non-farm payrolls, we typically look at 10 pieces of data that we call the leading indicators for non-farm payrolls. Four out of the ten releases point to greater job losses, putting the odds in favor of a weak non-farm payrolls reading in line with expectations. More specifically, the four-week moving average of initial jobless claims increased to a new 5-year high while continuing claims jumped 6 percent to 3.3 million. On the other hand, consumer confidence has improved somewhat with the pullback in oil prices from record highs, while the ADP employment report unexpectedly showed an increase in hiring. However, we are missing three of the leading indicators we normally watch – ISM Manufacturing, ISM Services, and Challenger job cuts – as they will not hit the wires until later on Friday and next week.

Arguments for Stronger Non-Farm Payrolls
1. ADP Employment Report Unexpectedly Rises 9k Vs. Expectations of -60k
2. Work Stoppages Fall To Zero As No New Strikes Are Reported
3. U of M, Conference Board Consumer Confidence Surprisingly Improves

Arguments for Weaker Non-Farm Payrolls
1. Initial Jobless Claims 4-Week Moving Average Jumps To New 5-Year High
2. Continuing Claims Jump 6% to 3.3 Million
3. Monster.com Index Drops 14% in July From A Year Ago
4. Help Wanted Online Index Declines For 5th Consecutive Month

Will May Non-Farm Payrolls be Better or Worse than June?
The majority of the leading indicators for non-farm payrolls indicate that July was a month of job losses, but there is an unusual amount of uncertainty surrounding this particular release. First of all, two of the key indicators that we normally utilize and are typically the most consistent – ISM Manufacturing and ISM Services – will not be released until after the non-farm payrolls announcement on Friday morning. As a result, our view of employment conditions in those two sectors is a bit blurred.

Nevertheless, though less-reliable, the ADP employment report unexpectedly reflected net increase of 9,000 workers thanks to hiring by small firms and in the services sector, which may help to alleviate some of the weight of job losses amongst manufacturers. Meanwhile, separate consumer confidence surveys by the University of Michigan and the Conference Board surprisingly improved during July. However, a deeper look into the Conference Board report shows that sentiment on the labor markets has steadily deteriorated, with more Americans saying that jobs are harder to get. As a result, despite the lack of more dependable leading indicators for non-farm payrolls, the odds are clearly skewed in favor for yet another round of gloomy employment data.

Could Non-Farm Payrolls Drop by 100k?
The US non-farm payrolls report is one of the most critical releases for the US dollar, not only because it is market-moving, but also because it can help us gauge the broad status of the economy. Despite the fact that GDP rose 1.9 percent in Q2, up from 0.9 percent in Q1, it is far too early to say that the US economy has successfully avoided a recession. A “recession” does not necessarily mean that GDP falls negative, as the National Bureau of Economic Research (NBER) defines it as “a significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” It could easily be argued that the slump in US GDP from 4.8 percent during Q3 2007 down to -0.2 percent in Q4 2007 and 0.9 percent in Q1 2008 represents a “significant decline.” Furthermore, these figures are often revised, as the -0.2 percent reading in Q4 was initially reported at 0.6 percent. Consequently, this advanced reading of Q2 GDP is by no means the final word on economic growth.

Over the past 3 decades, the US economy has gone through 3 recessions, according to NBER. In each of those 3 recessions, there was a string of job losses that lasted for a minimum of 10 months. Thus far, non-farm payrolls have fallen negative for the past 6 months, and the July report is anticipated to bring this tally up to 7. Some argue that the current downturn in growth could be more severe than the recession in the early 2000s due to the triple blow of a housing crisis, credit crunch and skyrocketing commodity prices. As if this weren’t enough, the odds are in favor of more severe job losses in coming months because in each of the past 3 recessions, the largest single month job loss was more than 300k! In this context, a 100k drop over the next few months is not only possible, but probable.

Will NFPs Have A More Lasting Impact?

US Dollar Reaction To GDP Short-Lived – Will NFPs Have A More Lasting Impact?
The release of US GDP figures proved to spark volatility for the US dollar on Thursday in a rather unexpected way. Indeed, while Q2 GDP accelerated 1.9 percent – up from 0.9 percent in Q1 – that was actually weaker than forecasts of a 2.3 percent gain. However, the most disappointing factor of this report that helped drive the US dollar lower initially was the downward revision of Q4 2007 GDP down to -0.2 percent from 0.6 percent, which marked the first negative reading since Q3 2001. This highlights the importance of revisions to key economic indicators as this was only the advanced release of Q2 GDP, and with two more rounds – preliminary and final – coming up during the next few months, today’s reports are by no means the final word on the status of economic expansion in the US. Yet, the greenback bounced right back within a few hours, leaving the currency virtually unchanged from yesterday’s close and suggesting that the US dollar rally may have further to go.

Nevertheless, there’s major event risk for US assets on Friday: non-farm payrolls. This is THE biggest market-mover for the US dollar on a short-term basis, and Friday is unlikely to be any sort of exception as the data is anticipated to reveal job losses for the seventh consecutive month. As we’ve noted in our NFP Preview, “Over the past 3 decades, the US economy has gone through 3 recessions, according to NBER. In each of those 3 recessions, there was a string of job losses that lasted for a minimum of 10 months.” As the number of negative NFP readings quickly adds up, the risks that we are currently in the midst of an economic recession increase. However, the forex markets are infamous for reflecting the short-term view, and if NFPs actually prove to be slightly better than expectations for a drop of 75K, the greenback could actually appreciate at 8:30 EDT. Furthermore, NFPs rarely have a lasting impact on price action beyond a few hours, and on a few occasions since the start of the year, the US dollar has actually had the opposite reaction to the sentiment reflected in the data on hand (strengthening when NFPs disappoint, and vice-versa). As a result, it is worthwhile for even the most fundamentally-focused traders to keep technical factors in mind.

Euro Slide May Continue On German Retail Sales, Swiss CPI Hits Nearly 15-Year High
Despite a pop higher during the US trading session, the Euro remains soft following a morning of mixed economic data. On one hand, the number of unemployed workers in Germany fell in line with expectations by 20,000 while estimates for Euro-zone CPI show that price growth accelerated to an annual pace of 4.1 percent, which marks a fresh 16-year high and is well above the European Central Bank’s 2 percent target. On the other hand, the Euro-zone unemployment rate picked up to 7.3 percent from 7.2 percent, pointing to broad weakening in the European labor markets. Clearly, inflation pressures persist throughout the Euro-zone, but will it be enough to convince ECB President Trichet to raise rates further. Unlikely. Recent PMI reports that indicated a contraction in business activity in both the services and manufacturing sectors are probably just the tip of the iceberg in reference to the slowdown in the Euro-zone’s economy, and given these circumstances, Mr. Trichet will have little room for maneuver in coming months when it comes to monetary policy. Looking ahead to Friday, German retail sales could weigh on the Euro, but more likely will simply serve as a good leading indicator for the composite Euro-zone report next week. Meanwhile, Swiss CPI slipped 0.4 percent during the month of July, but surged to a nearly 15-year high of 3.1 percent from a year earlier. Like much of the world’s economies, Swiss inflation is being driven by high energy and food prices, but since the Swiss National Bank is far more patient than central banks like the ECB, don’t count on threats of a rate increase anytime soon.

British Pound Remains Weak – Will the Downtrend Target 1.97?
While the British pound traded primarily on the whims of the greenback, the release of UK housing data did little to boost the currency as Nationwide home prices plunged 8.1 percent in July from a year earlier. This was the sharpest decline since at least 1991, adding to the already-abundant list of downside risks for the UK economy. On Friday, the PMI results for the UK manufacturing sector may do the same, as the index is anticipated to slip further below 50, signaling contraction for the third consecutive month.

Comm Dollars Remain Weak As Aussie, NZ Economies Falter
The Australian, New Zealand and Canadian dollars remained weak on Thursday as data from all of the regions were abysmal. In Australia, retail sales unexpectedly slumped 1 percent in the month of June and 0.6 percent in Q2, which was actually the worst reading since Q3 2000. In New Zealand, business confidence fell for the first time in four months in July to -43.2 from -38.7, giving the RBNZ even more reason to consider cutting rates again this year after reducing the official cash rate last week to 8.00 percent. In Canada, GDP surprisingly slipped 0.1 percent in May due primarily to a slowing in natural gas and crude oil production. Overall, the Australian, New Zealand, and Canadian dollars could be in trouble in coming months, as many of these regions depend on export demand for growth and a global economic slowdown threatens to lead demand for commodities to drop.