By DailyFX – Dollar Yields to No One – A wild night of trade in the currency markets, we wrote on Friday, as dollar was… … bid across the board after US 10 year yields rose to 5.24% their highest value since July 2006.

Indeed yield was the story
of the week as the greenback gained 60 basis points on the euro, 70 on
the pound and 50 on the franc. Only the commodity dollars, helped by
their own yield stories stood up to the greenback.

The buck also received some help on the economic front, as ISM Services
skyrocketed to 59.7 from 55.8 indicating that demand in the largest
sector of the US economy remains healthy despite the persistent woes in
housing. Finally on Friday, dollar bulls also saw a nice contraction in
the Trade Deficit which shrunk to -58.5B from 63.5B initially
projected. Ironically enough the buck saw little price action from that
news as 10 year yields receded to 5.12% by Friday afternoon proving once
again that bonds now control in both equities and FX.

Next week may prove to be more of a challenge for the greenback. The
action wont kick off until Wednesday, when Retail Sales numbers print.
Initial indications are that the number may be soft no surprise given
the high cost of gasoline and flat wage growth. If however, the Retail
number manages to beat expectations the rest of the week could be very
friendly to dollar longs as inflation gauges are likely to run hot and
talk will focus on a possible Fed rate hike in price pressures persist.—
BS

Euro – No Definite Dates in Sight

On Wednesday we wrote, the marquee event of the day will be Mr.
Trichets press conference after the expected rate hike to 4% with
traders focused on only one question when will the next hike occur?
Typically, Mr. Trichet refuses to assign specific date targets to any
future policy moves and we anticipate today to be no different.
Although the EZ economy continues to perform well, ECB officials are
unlikely to rush their next policy action especially with headline
inflation contained at 1.9%. Instead we believe that they will want to
digest the impact of the current hike for at least several months before
considering any further tightening.The scenario played out exactly as
we expected with Mr. Trichet remaining non-committal as to ECB future
plans and the euro quickly ran out of gas. The unit was hurt further by
the news that both German Factory Orders and Industrial Production fell
far worse than forecast suggesting that the high value of the currency
may be finally starting to weigh on the regions most important sector.

Next week, the EZ calendar carries very little important even risk with
just a slew of second tier reports that are unlikely to impact the price
action for more than 20 points at a time. The direction of the pair will
most certainly be driven by the US events as traders watch bonds, US
Retails Sales and inflation reports. For the time being the EURUSD
continues to bounce around in a wide range between 1.3650-1.3350 but if
the news of the week prove positive for the buck the pair could easily
tumble to the lower 1.3000 to test its true supporting that region.— BS

Yen – Carry no Problem?
On Friday Japans Mr. FX the finance ministrys top currency official
Hiroshi Watanbe brushed off fears of an unwinding of the yen carry trade
despite this weeks sharp rise in US bond yields. Mr. Watanabe,
vice-finance minister for international affairs, told reporters that he
did not think the yen carry trade has any immediate risk of unwinding
adding further that, The size of any carry trades that would unwind is
relatively small compared to the entire foreign-exchange market.”
Whether Mr. Watanabe will be correct remains to be seen but for now the
carry trade stayed in place and the yen continued to suffer for it. But
as we cautioned on Friday, Although the yen did not suffer as badly as
the other major currencies, it did not escape dollars wrath. Tonights
story was clearly all about dollars strength rather than simply carry
trade liquidation. Nevertheless most of the yen crosses declined as well
as the bump in US yields in likely to weigh on US equities which in turn
will create new bouts of risk aversion and further unwinds in the carry
trade.”
For the time being the yen held its ground raising 20 basis points for
the week. Certainly the carry trade appears to be very tired, but
Japanese monetary officials are unlikely to expedite the unwind. This
weeks calendar brings yet another BOJ rate decision which likely to be
an non-event. Even if its followed by hawkish rhetoric the market will
most demand proof before believing that BOJ officials are serious about
monetary tightening. Thus in the end yens fate still appears to be tied
to risk aversion rather than any economic developments form Japan. — BS

British Pound Could Make a Comeback on CPI

While most fundamental indicators for the UK last week signaled rosy
times for the economy, the announcement that the Bank of England did not
want to raise rates led GBPUSD lower. These declines proved to be a
slippery slope as an 80 point drop quickly turned into a 260 point slump
with GBPUSD ending the week near 1.9650. While the BOEs decision was
widely expected by the markets, there was a bit of risk that the
surprise-prone central bank would seek another round of policy
tightening. Nevertheless, as weve mentioned before, after the minutes
from the May meeting showed that the central bankers had actually
discussed raising rates a full 50 basis points, it is worth noting that
the BOE only took rates 25 basis points higher in order to allow more
time to gauge the effects of previous policy tightening. Thus, it made
sense that the bank left rates steady in June, and they will likely do
so again in July. In fact, we believe that the Bank will want to see how
CPI fares over the next few months and will go on to hike in August,
barring a sharp drop in inflation pressures.

This week, GBPUSD could be in for a bounce based on both technical and
fundamental factors. Looking at the daily charts, the pairs plunge was
stopped short at seven month trendline support and the 50.0% fib of
1.9183-2.0131 at 1.9657. Should GBPUSD hold up against support, price
could bounce up towards 1.9775 with the help of strong economic data.
Inflation reports may only underpin estimates of an August hike as PPI
and CPI are both anticipated to remain elevated, while signs of further
tightening in the labor market will feed into concerns of mounting wage
pressures. Furthermore, Retail Sales are forecasted to rebound as well,
signaling that consumption remains healthy despite higher interest
rates. However, with BRC Retail Sales for the same month indicating a
sharp slowdown, there are major downside risks for this particular
release. Nevertheless, should speculation about the BOEs future policy
action remain the dominant theme in British pound trade, GBPUSD gains
will likely resume by mid-week.

Swissie May Remain Sour Even With A SNB Hike

Encouraging economic data out of Switzerland was not able to lend the
Swiss franc strength last week as technical factors took hold and
carried USDCHF 200 points higher to break a critical resistance level. A
one year trendline and the 200 SMA did little to slow the USDCHF ascent,
and while the price action had more to do with the market-wide US dollar
bid tone, Swissie barely stood a chance. Looking at fundamental data,
the release of the Swiss Unemployment Rate at 2.7 percent the best
reading since October 2002 should have bid well for the national
currency, especially ahead of the Swiss National Banks quarterly policy
meeting on June 14th. However, with interest rate differentials still
working against Swissie – even with another rate hike to 2.50 percent —
the currency will remain susceptible to broad carry trade flows.

As we mentioned, a rate hike by the SNB this week isnt likely to do
much for the Swiss franc in the long-term, as the carry trade will
likely continue to work against the currency. However, USDCHF may see a
brief, sharp dive towards 1.2312 (trendline resistance and 200 SMA are
now support) upon the announcement of rate normalization on Thursday as
such policy action is undoubtedly bullish for Swissie. Nevertheless,
once market reaction cools down and broader sentiment comes back into
play, USDCHF will likely continue its push towards 1.2450.

Will the Canadian Dollar Resume Its Rally?

Has the Canadian dollar rally finally been exhausted? Were not
prepared to call a bottom yet, but 1.0550 held up as solid support for
USDCAD last week. Economic data hasnt necessarily been working in the
favor of Loonie either, as Building Permits for the month of April
contracted more than expected at a rate of -8.4 percent. However, given
the volatile nature of this release (the figure surged 26.5 percent the
month prior), market reaction was at a minimum. Meanwhile, Ivey PMI
proved lackluster, as the business activity gauge rose to a
softer-than-expected 62.7, though by continuing to improve and showing
expansion in the sector, the release still underpins a Loonie bid tone.
Finally, labor market data was similar to Ivey PMI, in that the release
was weaker-than-expected but still showed improvement.

This week will serve as a major test for USDCAD, as thin data flow
could leave Loonie to flounder. New Housing Prices are estimated to grow
0.3 percent once again in the month of April, though USDCAD reaction
will be mild given the releases low market-moving status. At the same
time, the Capacity Utilization Rate is predicted to edge higher. Thought
to be a leading indicator of inflation, the announcement may give Loonie
a brief boost albeit a small one. Nevertheless, regardless of the
scheduled releases this week, markets have little reason to sell-off the
Canadian dollar considering that oil prices remain lofty, CPI is still
above 2.0 percent, and exports are holding up well. All of these factors
underpin the case for a hike by the Bank of Canada in July, and with the
US Fed likely to remain on hold throughout the year, shifting interest
rate differential are slowly working in the favor of Loonie. As a
result, markets should remain cautious of trying to capture a turn in
USDCAD, as there is little fundamental basis for a full turnaround and
the pair could indeed continue to plow down through 1.0550.

Aussie Rallies On Strong Data, A Flood To Carry Trades

Among all the central bank decisions last week, the outcome for the
Reserve Bank of Australias deliberations was one of the unknowns.
Ultimately, the policy group, led by Governor Glenn Stevens, held the
overnight cash rate steady at a six-year high 6.25 percent as economists
had expected. However, the other indicators filling out the economic
calendar may be lying the ground work for another 25 basis point hike
sometime in the near future. The overcrowded docket reported economic
strength on all fronts. The business sector was proving it was
weathering a crimp from wage inflation and a local currency at
multi-decade highs. A wrap up on first quarter corporate operating
profit reported a booming 7.6 percent increase over the first three
months of the year for the best performance since the second quarter of
2005. Insuring that the outlook is just as bright as the past, the
Westpac Industrial Survey for the current quarter also rose reflecting
the strength of strength in demand and projections that rates are on
hold for now. Jumping sectors to the housing market, building approvals
for the year through April crossed back into positive territory for a
4.5 percent pick up. A far more impressive improvement though was seen
in the employment numbers for May. Firms took on nearly four times as
many new workers as economists had forecasted, which in turn cut the
employment rate to a 33-year low 4.2 percent. Encompassing all of this
data and putting the exclamation point on the rate outlook, first
quarter economic growth accelerated to a nearly three-year high 3.8
percent pace.

Looking ahead to this week, the Aussie dollar will look to catch a
considerable draft from last weeks whirlwind calendar; though fresh
fundamentals will have their influence on the currency. There are only a
few second-tier reports on deck, though consistency with last weeks
bullish data run could certainly leverage the datas impact. On Tuesday
morning in Australia, the NAB Business Confidence survey will provide an
up to date read on corporate sentiment. On the following day, Westpac
will release its gauge on consumer optimism, which will no doubt be
colored by recent employment and wage numbers not to mention overall
growth conditions. Finally, the fundamentals schedule will wrap up with
the HIA New Home Sales Report for April, which will offer a look into
how Aussies spending habits are really holding up to current interest
rates. While macro data will certainly have its place in FX trading next
week, the real action may come on trends in risk aversion and carry
trade. In the past week, a sell off in global equities sparked an
unwinding of risky trades across the board. However, a hike from the
RBNZ, reminded currency traders of why they were sticking with the
carry. Backed by a sound economy and a 6.25 percent benchmark lending
rate, the Aussie dollar will be a leader should the carry gain momentum.

New Zealand Dollar Surges On Hike With Doors Open For Another

There were two events scheduled for release in New Zealand last week,
but traders were really only interested in one the Reserve Bank of New
Zealands decision on interest rates. The central bank, helmed by
Governor Alan Bollard, surprised economists – but not the market
according to the interest rate curve prior to the event – when the
monetary policy authority lifted the overnight lending rate 25 basis
points to a nine-year high 8.00 percent. This is the third increase from
Governor Alan Bollard since March, and has only further engrained the
New Zealand dollars title as the symbolic leader of the carry trade.
However, the rate hike itself was not most market-moving aspect of the
announcement. What truly stoked the kiwi was Bollards unflappable
hawkishness. Charged with keeping inflation between 1 and 3 percent, the
central bank governor kept the door wide open for further tightening
when he said consumer spending and housing demand are fanning inflation
to uncomfortably high levels. Interestingly, immediately after lifting
the overnight lending rate and opening the flood gates to even more
foreign capital, Bollard theorized that the exchange rate is at levels
that are both exceptionally high and unjustified on the basis of New
Zealands medium-term fundamentals. Whether this was a weak attempt to
talk the currency down or if the central banker is genuinely confused is
unclear.

For the week ahead, the New Zealand dollar has already made its
technical breaks and is well-equipped to extend its rally as rate
expectations offer greater incentive for foreign investors to direct
their capital to the island nation and its domestic currency. As it
stands, interest rate markets have almost fully priced in another rate
hike by the end of the year and there is even a 30 percent chance for a
lift to 8.25 percent at the July 26th meeting. Looking at the economic
calendar though, rate forecasts could change dramatically as a number of
critical indicators are set to weigh in on Bollards key trouble areas
for persistent inflation. The two headline reads for the week will be
the House Prices indicator for May and retail sales report for April.
There is no specific time or consensus attached to the housing read, but
the spending number is expected to pass the month unchanged. Softer
reads from both indicators would certainly open the door to doubt over
the necessity of another rate hike. Keep in mind, consumer inflation ran
2.5 percent in the first quarter, well within Bollards range. Whats
more, the central banks own projections see pressures easing to a 2.2
percent pace next year. Another barrier to hawkish speculation may be
the ANZ business report and first quarter manufacturing activity, which
may reflect the pain a currency at 25 year highs is inflicting.— JK

DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: research@dailyfx.com