Dollar downbeat ahead of a busy week for FX markets

The key theme in the FX markets at the moment is ongoing weakness in US dollar, which sold off further last week following Janet Yellen's dovish testimony and disappointing economic data. The Federal Reserve Chairwoman indicated that rates may "not have to rise all that much further to get to a neutral policy stance." Yellen reiterated that the central bank remained data-dependent and was watching inflation closely. Friday's weak US CPI and retail sales thus convinced the markets what they had long predicted: that the Fed may be forced to reduce stimulus at a slower pace than they had indicated. But it is not just the recent soft patch in US data which has weighed on the dollar.

Dollar weakness also due to other central banks turning hawkish – will ECB follow suit?

The fact that some other key central banks have meanwhile turned hawkish has also driven the value of foreign currencies up relative to the greenback. As global economic conditions improved and inflation rose, the likes of the Bank of England have started to talk up the prospects of raising interest rates while the Bank of Canada has even gone a step further by becoming the first western central bank after the Fed to hike interest rates following many years of holding monetary policy extremely accommodative. Among the other major central banks, only the Bank of Japan, Swiss National Bank and the European Central Bank are still dovish. Two of these banks will be making their decisions on interest rates this week: the BOJ and ECB, both on Thursday. The former has already made it clear that it won't be tapering its massive QE stimulus programme any time soon, let alone raise interest rates. The ECB on the other hand has given mixed signals to the markets in terms of tapering QE. The market seems convinced that out of these three remaining dovish central banks, the ECB is going to be the next to turn hawkish, hence the recent rally in the EUR/CHF and EUR/JPY pairs. If the ECB were to give the strongest signal yet that it will indeed reduce QE earlier than expected, then we would expect the euro to surge higher and European stocks to sell-off later on this week.

Chinese data beats; more to look forward to from Australia, NZ, UK and Canada this week

The markets have convinced themselves about the ECB becoming the next central bank to turn hawkish because of the fact economic data has been improving in the Eurozone economy at a faster pace in recent times than in Switzerland or Japan. Unfortunately there isn't a lot to look forward to this week from these regions in terms of data, except those central bank meetings as already mentioned. Nevertheless this week promises to be a busier one for other regions. We've already had stronger than expected Chinese data overnight. GDP (+6.9% q/y), industrial production (7.6% y/y), fixed asset investment (+8.6% ytd/y) and retail sales (+10.3% y/y) all topped expectations. These follow the better-than-expected trade figures that were released last week. So the health of the world's second largest economy is apparently improving again. Looking forward to the rest of the week, the quarterly (and thus impactful) release of New Zealand CPI is at 23:45 BST tonight (Tuesday morning NZ time), followed by UK CPI and German ZEW Economic Sentiment Tuesday morning. US building permits and housing starts, and crude oil inventories are among Wednesday's highlights. Thursday will begin with the release of Australian employment figures in the early hours of the day, followed by the Bank of Japan policy announcement, UK retail sales and the ECB's rate decision and press conference. On Friday, Canadian CPI and retail sales will take centre stage.

So, there's something for everyone this week. We expect to see heightened volatility in a number of FX pairs. As things stand, the Australian and Canadian dollars, the pound and the euro look among the most bullish currencies out there. The US dollar is among the weakest. We expect this trend to continue this week, unless the upcoming data releases or central bank meetings deliver surprise outcomes.