USD: Prospect of Further Weakness

The end of the month has brought unusual volatility to the financial markets with currencies and equities seesawing throughout the North American trading session. Weaker than expected second quarter GDP numbers were met with stronger manufacturing data out of the Chicago region. The theme in the markets continues to be dollar weakness with the greenback selling off against almost all of the major currencies. The euro may have ended the NY session lower but it rebounded well off earlier lows. As we have been saying throughout the past two weeks, Bernanke stuck a knife through the dollar with his dovish testimony on Capitol Hill and since then every single piece of incoming data has either verified his pessimism or is looked at with skepticism.

Prospect of Further Dollar Weakness

Next week's economic data will most likely not provide any support for the dollar. Manufacturing and service sector ISM data are scheduled for release along with the July non-farm payrolls report. Despite the rise in Chicago PMI, manufacturing activity in the NY, Dallas and Philadelphia regions slowed dramatically in the month of July. At the same time, no major improvements are expected in the service sector as the economy slogs forward. Non-farm payrolls are also expected to fall for the second month in a row. Private sector payrolls are expected to rise, but the government is planning to go through massive headcount reductions now that census is practically done. A stronger rise in private payrolls would be looked at positively, but at the end of the day, the loss of a hundred thousand government jobs would still have a negative impact on consumer consumption. Therefore, we believe that the dollar is vulnerable to further weakness. U.S. bond yields continue to fall as 2 year yields hit a record low of 0.539 percent intraday. The lack of yield in the credit market has made the dollar less attractive.

U.S. Recession Deeper Than Previously Thought

The latest U.S. GDP report shows that the recovery in the first quarter was particularly strong in the U.S. but the troubles in Europe and lackluster demand limited the extent of the recovery. Given the recent disappointments in U.S. data, there is a good chance that the pace of growth has slowed even further. Although first quarter growth in the U.S. was revised a full percentage point higher from 2.7 to 3.7 percent on more inventories and a smaller trade gap, second quarter growth slowed to 2.4 percent. Weaker personal consumption and a decline in exports contributed to the slower recovery between April and June. The upward revision to the Q1 data should have helped to offset the negative sentiment triggered by a weaker Q2 release, if not for the Commerce Department's note that due to additional revisions, the recession was deeper than previously estimated. Originally the Commerce department had said the economy shrank by 3.7 percent between the fourth quarter of 2007 and the second quarter of 2009 (the period that the U.S. fell into recession), but after a revision to the household spending data in 2009, the economy actually contracted by 4.1 percent. If the U.S. economy continues in its current trajectory and fulfills Bernanke's prophecy of unusual uncertain in the coming months, there is a good chance that the U.S. economy will fall short of 2 percent growth in the third quarter.

EUR: WILL 1.30 HOLD?

The euro may have ended the day lower against the U.S. dollar, but the fact that it has held near 2 month highs for most of the week is a testament to the strength of the currency. The 1.30 level is not far from current prices which make a break back below not entirely difficult but given the continued prospect of weaker U.S. and stronger German data next week, the odds still favor sustained gains in the EUR/USD. More importantly, we anticipate optimism from European Central Bank President Trichet when he gives his press conference after the monetary policy meeting. Trichet will most likely pat his cohorts on the back for a job well done on the stress tests and recognize the recent improvements in economic data. Although German retail sales fell 0.9 percent, it was only because there was a strong upward revision to the prior month's report. Originally, the Federal Statistics Office had reported an increase of 0.4 percent in consumer spending during the month of May but after the revisions, spending was revised up to 3 percent, the highest level in more than 2 years. Therefore taken in aggregate, the report was not nearly as bad as the headline number especially when you consider that the year over year gain was revised up from -0.7 to 3.1 percent. Earlier this week, we learned that German unemployment declined for the 13 th consecutive month which should provide additional support for German retailers. Overall, business and consumer sentiment has improved across the Eurozone which we expect Trichet to acknowledge. Also, he will probably have good things to say about the market's response to the stress tests and this positive sentiment should keep the EUR/USD above 1.30 even if the ECB has no plans to raise interest rates in the near future. Meanwhile a steady reading in the KoF leading indicator did not have much of an impact on the Swiss Franc. Next week brings retail sales, manufacturing PMI, consumer prices and the unemployment rate, which will collectively give us a much better sense of how the Swiss economy is performing.

GBP: SHRUGS OFF WEAKER CONFIDENCE

The British pound continued to extend its gains against the U.S. dollar, rising to a fresh 5 month high above 1.57 intraday before retreating. In fact, the pound has been in such a pronounced uptrend that with the latest rally, the currency is close to recovering all of its month to date losses against the euro. The rally is particularly impressive considering that consumer confidence fell to the weakest level in 11 months according to the GfK report. Fears of higher taxes and lower welfare spending as well as other cuts by the government may have respondents already factoring in the "likely recessionary impact of the government's announcements." Britons grew more pessimistic about their personal financial situation over the next year and about the outlook for the U.K. economy. However sterling investors are unfazed as the latest data still points to stronger growth and spending. The truth will be revealed in next week's manufacturing, service and construction sector activity reports. Like the European Central Bank, the Bank of England also has a monetary policy meeting on tap, but without any post meeting press conference, the BoE is not expected to reveal anything new. Rates will be left unchanged along with the size of their Quantitative Easing program. The statement will contain no details and as usual, we will need to wait for the minutes to be released to get a better of sense of how many monetary policy committee members believe that inflation will actually recede. The next level of resistance in the GBP/USD is at 1.58 and developments next week should not stop the currency pair from testing that level.

CAD: GDP COMES UP SHORT

The Canadian, Australian and New Zealand dollars pressed higher despite the decline in equities on the heels of fixing related flows. There was a rumor in the market that five billion Aussies needed to be bought at the London fix (16:00 London Time) which provided consistent support for the commodity currencies during the Asian and European trading sessions. Once the fixings were over, the comm. dollars gave back their earlier gains. Canadian growth fell short of expectations in the month of May with GDP rising only 0.1 percent compared to a 0.2 percent forecast. Weaker service sector activity offset stronger goods production that month. In New Zealand, building permits grew 3.5 percent in June which was also much weaker than the market had anticipated. In the coming week, there are quite a bit of market moving economic events in the commodity producing countries. Australia has a monetary policy announcement along with retail sales, the trade balance, service, manufacturing and construction sector activity reports scheduled for release. After the softer consumer price release last week, the Reserve Bank is expected to hold interest rates steady. Their tone will likely be one of continued caution. New Zealand on the other hand has second quarter employment numbers scheduled for release and given the recent rate hike, there is a good chance that the labor market improved. Canada has IVEY PMI and their employment report scheduled for Friday which should bring some volatility to the currency.

JPY: WEAKER DATA A BIG CONCERN

Weaker economic data out of Japan had only a limited impact on the Japanese Yen. The currency ended the North American trading session higher against every major currency except for the Canadian dollar and British pound. Last night's barrage of economic releases proved to be a big disappointment for Japan. Manufacturing activity slowed in the month of July while the unemployment rate ticked higher. Household spending increased but it was offset by a sharp drop in industrial production and steep declines in consumer prices. Housing starts also grew at a much slower place in June. These softer reports indicate that deflation remains a persistent risk in Japan and that growth in the industrial sector will most likely stagnate in the third quarter. The fall in industrial production is a very big red flag for Japan because it can be perceived as a leading indicator for overall trade activity. When industrial production plunges, there is a good chance manufacturing activity is slowing along with export demand. In contrast to this past week, next week has no major economic releases for Japan.

GBP/USD: Currency in Play for Next 24 Hours

The GBP/USD will be the currency pair in play for Monday. From the United Kingdom, we expect the Manufacturing Purchasing Managers' Index for the month of July at 4:30 ET or 8:30 GMT. The United States is set to release the Institute for Supply Management's Manufacturing PMI and Construction Spending figures at 10:00 ET or 14:00 GMT.

For the seventh consecutive day, GBP/USD remains within the Buy-Zone, which we determined using Bollinger Bands. After suffering heavy losses in mid-May, the pair has been in a very strong bullish channel. The nearest level of significant support lies at the 1.5605 level, which is the 61.8% Fibonacci Retracement from the January high of 1.6457 to the May low of 1.4226. If this level is broken, the 50% Fibonacci Retracement of 1.5341 should serve as further support as it coincides with channel support and the 20-Day Simple Moving Average. The closest resistance is at the 1.5810 level, which provided strong support in late 2009. If the pair breaks above this level, the 78.6% Fibonacci Retracement of 1.5980 should serve as the next strong resistance.