Is the Dollar Baaack?

USD/JPY defied fundamentals today to hit a 7-week high above 112. The greenback strengthened against all of the major currencies with euro leading the slide.   Retail sales grew at its slowest pace in 6 months but the dollar rallied because every policymaker who spoke on Friday said more tightening beyond September is needed. Even FOMC voter and Fed President Brainard who is traditionally a dove suggested that the Fed could continue to raise rates beyond the long term neutral rate. Evans who is not a voting member of the FOMC described the economy and labor market as very strong and suggested that 4 hikes for 2019 is still reasonable because he wouldn't be surprised if inflation goes a little above 2%. Kaplan agreed that the U.S. consumer is strong. Hawkish comments such as these drove 10 year Treasury yields above 3% on an intraday basis on Friday and this move took USD/JPY to its highs of the day above 112. The Federal Reserve is still expected to raise interest rates this month and that's the only thing that matters. The trend is strong in USD/JPY and the pair could continue to rise but it will be vulnerable to the Bank of Japan's outlook and trade headlines. No changes are expected but the BoJ has been actively engaged in stealth tapering and investors will be watching closely for any comments on these actions.

The momentum for EUR/USD shifted back to the downside with today's reversal. The euro rallied after the ECB's meeting on Thursday but today, there were reports that some policymakers wanted a more cautious tone that suggested the risks were tilted to the downside. Data was also weak with the Eurozone's trade surplus shrinking to its smallest level in 4 years in July. The divergence between Draghi's outlook and the performance of the economy makes next week's inflation and economic activity reports very important. If CPI and PMIs also surprise to the downside, EUR/USD will fall to 1.15. However if Draghi is right and the PMIs show that the outlook for the economy remains bright, EUR/USD could squeeze back above 1.17.

Sterling turned lower on the back of U.S. dollar strength and conflicting Brexit headlines. Brexit talks are moving in a positive direction but the Irish border is still the big problem. UK Brexit minister Davis thinks they are closing in on a deal but the EU denied the progress. Either way Brexit headlines and UK data puts sterling in focus next week with consumer prices and retail sales numbers scheduled for release. GBP/USD ended Fridayat its lows, putting the pair at risk of testing 1.30.  

Although the Australian and New Zealand dollars hit fresh 2 year lows this past week, both currencies rebounded on the back of stronger data. In Australia business conditions improved and job growth strengthened and in New Zealand manufacturing activity accelerated for the first time in 4 months. There are no economic reports from Australia but second quarter GDP numbers are due from New Zealand next week. Despite the decline in dairy prices, stronger retail sales and trade activity should bolster growth in Q2. Trade headlines will continue to pose a risk to both currencies as the U.S. threatens China with additional tariffs while proposing a new round of trade talks. Both currencies turned lower on Friday, shifting momentum back to the downside.

Meanwhile Canada - U.S. trade talks has yet to yield any meaningful progress.Canadian Foreign Minister Freeland should be back next week to continue negotiations. The main issue is dairy - Canada restricts how much foreign milk is sold to the benefit of their local industry but the U.S. wants those restrictions relaxed so U.S. producers could sell more milk and cheese to Canada. Freeland is the first to admit that plenty of work still needs to be done and according to reports this week President Trump is willing to drop Canada from the U.S.-Mexico-Canada pact if they don't agree to his terms. The talks haven't completely broken down but investors aren't happy with the progress so far hence the recovery in USD/CAD. Canada's economy is also will be in focus next week with retail sales and consumer price reports due for release.