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British pound: Busy week ahead

- US Dollar: Selectivity Remains the Key - Euro: Trichet's Hawkish Comments Put to the Test - British Pound: Busy Week Ahead

DailyFX Fundamentals 05-09-08

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar: Selectivity Remains the Key

The US dollar has satisfied both bulls and bears this week depending upon the currency pair in question.

In last Friday’s Daily Fundamentals, we said that “although we expect a continual rally in the US dollar, traders need to be careful of what they buy.”

We had indicated that the dollar could rally against the Euro and British Pound but was nearing resistance against the Japanese Yen. The moves that we were looking have already happened and are now becoming slightly overextended.

However for the most part, the downtrend in the dollar against the Japanese Yen and its uptrend against the Euro and British pound should remain intact but being selective will continue to be the key to trading currencies in the coming week.

The marquee event of the week will be the US retail sales report and even though logically, consumer spending should falter, it may not be as bad as the market expects. The drop in consumer confidence and non-farm payrolls point to weakness, but the rise in food and energy prices and the stronger earnings from companies such as Wal-Mart and Costco suggest otherwise.

The main reason why the market usually has a big response to incoming consumer spending data is because of its impact on a central bank’s monetary policy decision.

However with the Fed, a pause in June has already been discounted by the market. The US economy has weakened significantly over the past few months and will probably to weaken in the coming months, but after having cut interest rates by 325bp since August, the Fed has decided that it is time to shift their focus to inflation.

Oil and corn prices hit a new record high, making price pressures a growing concern. Unfortunately for the Fed, they have no room to raise interest rates, leaving the US dollar as one of their only tools to curb inflationary pressures.

By hinting that they will be taking a break from cutting interest rates, they have already engineered some stability in the US dollar. In addition to the retail sales report, we are also expecting consumer prices, the Philly Fed survey, industrial production, and housing starts next week.

Euro: Trichet’s Hawkish Comments Put to the Test

Despite signs of slowing growth, European Central Bank (ECB) President Claude Trichet remained characteristically hawkish at the press conference following Thursday’s monetary policy decision.

Next week, his hawkishness will be put to the test with GDP and industrial production reports due for release. The latest price action in the Euro suggests that the market is still skeptical of how long the ECB can maintain their current stance.

Perhaps Trichet needs to see a drop in employment before he caves. In the meantime, the ECB’s hawkishness cannot be ignored. Part of the reason why the EUR/USD fell from 1.60 down to 1.5280 on Thursday was speculation that the ECB may be less hawkish.

Now that they have proved otherwise, there could be some profit taking on Euro shorts. Yet it will be just a matter of time before weakening economic data forces the European Central Bank to shift their focus. By that time, the ECB could be making the first interest rate cut when the Federal Reserve is nearly done.

British Pound: Busy Week Ahead

The British pound extended its losses against the US Dollar, as investors remain confident the Bank of England should be cutting rates in the near future.

Despite the lack of any significant economic news, investor sentiment remained bearish, as Experian expects the UK financial-services industry to cut 10,000 jobs over the next three years and house prices to fall 7.9% over the next two years.

The British pound should be a big focus in the week ahead with PPI, employment and the Bank of England Quarterly Inflation report due for release.

Oil prices are setting new records which will keep the central bank hawkish, but at the same time, they may express concern about growth. We continue to expect the British pound to underperform the US dollar as the economy continues on its downward spiral.

The Diverging Performance of Commodity Currencies

There has been a sharp divergence in the performance of the Australian, New Zealand and Canadian dollars this week.

The Aussie has held near its year to date highs thanks to hawkish comments from the Reserve Bank of Australia and stronger than expected employment numbers.

The New Zealand dollar on the other hand has plummeted to three month lows as employment falls by the most in 19 years. The Canadian dollar has been stuck in a very tight trading range and is now making another attempt to break lower on the back of stronger employment numbers and record oil prices.

Relative performance has played a big role in the price action of the three commodity currencies but that could change in the coming week with no major economic data released from any country other than New Zealand, who has retail sales and producer prices on their calendar.

Risk Appetite Continues to Pressure Carry Trades

The Japanese Yen has had a very good week as investors continue to curb their risk appetite. There will be a lot of Japanese economic data released next week, but it remains to seem whether this data will matter for the Yen.

Money Supply and Broad liquidity figures are expected to be unchanged, as BoJ officials remain reluctant to increase liquidity in fears of fueling further inflation.

In contrast, Bank lending and Machine Tool Order figures should decline, as businesses remain sceptical about global demand, and contain themselves from expanding.

Bankruptcies and Eco Watchers Survey figures should be gloomy, as dejected consumers cut back on spending, and in the process hurting overall business sentiments, as local demand for products continues to decline.

Near the end of the week, Machine Order, GDP and Consumer Confidence figures should help confirm investor fears that the once recovering economy has slowed again.