The ostensible inertia of dollar weakness was upset last week

USD – The ostensible inertia of dollar weakness was upset last week as America’s currency staged a massive rebound on the back of economic data that weren’t quite as-bad-as-expected. The Richmond Fed Manufacturing Index “only” fell to 0 in March (versus -1.5% exp.), while the Existing Home Sales Index for the same month printed at 4.93M (versus 4.92M exp.). Furthermore, the closely watched Durable Goods Order (March), while dropping to -0.3% overall, showed improvement from the prior -1.7%; moreover, excluding transportation, the reading demonstrated a stalwart amelioration to 1.5%. The mitigation in Initial Jobless Claims (342K vs. 372K prior) also helped to underpin dollar sentiment. The sanguine data, notwithstanding, last Friday’s University of Michigan Consumer Confidence revealed a downside adjustment to a new 26-year low, standing as a poignant reminder of why market participants are wary about the future outlook of the world’s largest economy and its currency. All eyes will be focused on this week’s triad of key data releases—Wednesday’s Q1 2008 GDP release (a negative reading would undo much of the dollar’s recent gains), the FOMC rate announcement later that same day (expectations for a 25-bps rate cut has now dropped to 75% from 100% during the week prior), and Friday’s NFP reading (expected negative reading for the 4th consecutive month). Expect another volatile week in currency markets. However, with a growing sense that the US credit crunch is easing and that the worst is behind us, markets have more reason to be optimistic for an H2 turnaround for the US and USD.

EUR – The euro begins the week with a softer tone at $1.56 following last week’s sharp drop. Last week saw one of the best and worst weeks for the euro as the single currency climbed to an all-time peak of 1.6018, only to fall back to 3-week lows. The euro rose after hawkish comments from ECB member Noyer that the Central Bank would do what was necessary to bring inflation back within target. Noyer subsequently moderated his comments, deflating the euro’s gains. The euro continued its descent, breaking technical levels and falling $0.04 over 3 days to multi-week lows at 1.5553. The euro’s dramatic reversal after failing to hold gains above $1.60 is leading many to point towards further euro weakening in the near- term. With German Ifo—an index of business confidence—falling to 2-year lows at 102.4 last week and continuing mixed messages from the ECB, the outlook for the Eurozone appears less assured and as a result, causing many to reconsider euro strength.

JPY – Asian finance ministers have suggested of late that Asian governments should form a $100B pool of foreign reserves by 2010 to prevent a repeat of the region’s financial crisis from a decade ago. The yen rose last week for the first time in a week as a decline in Asian stocks prompted investors to pare holdings of higher yielding “carry-trade” assets. The Japanese monthly small business survey showed the largest contraction in over a year with a 9.8% drop in March. Japanese exporters announced last week that they would remain profitable with a yen trading above 104.00 per dollar or weaker.

GBP – The pound fell from a two-week high against the dollar last week prior to the release of the BoE minutes from its policy meeting this month where it dropped the overnight rate by 25-bps to 5%. Sterling has declined 9% vs. euro thus far in ’08. This precipitous decline may put the BoE on hold from further rate cuts as a weak currency would likely spur inflation. Wage negotiations failed to yield higher pay increases for workers last week, widening the gap between wages and inflation. BoE policy makers say they're watching wage negotiations for signs that faster consumer-price inflation is becoming entrenched in the economy.

CAD – The commodity-linked loonie rose against the greenback this morning, boosted by record oil prices to $119.93 a barrel. However, even with oil as a key Canadian export, CAD was unable to hang on to its gains. Much of the currency's 60% rise since 2002 has been linked to rising oil prices. Furthermore, prices for oil are up nearly 25% since the start of the year, whereas the CAD is down over 2%.

MXN – Last week, Mexico's benchmark bond headed for the biggest weekly decline in more than a year after a report showed annual inflation rose. Speculation that Banco de Mexico will keep lending rates unchanged through 2008—preserving the lending-rate advantage over the US—will likely support further gains in the peso. Mexico's benchmark yields 525-bps more than the Federal Reserve's 2.25% target rate.

CNY – The Chinese yuan is slightly weaker at 7.0020 amid sentiments that Chinese authorities will moderate the yuan’s pace of appreciation. Market participants are paring back expectations for more gains, following reports that a growing number of companies are being negatively affected by yuan strength.

Last Week’s Currency Highs and Lows and Forecast