5 things to watch this week

• March 6, 2006
• Kathy Lien

US Dollar

Friday was another exciting day in the currency market.  First the dollar sold
after the weaker consumer confidence numbers, but the rally did not extend very
far as traders treaded carefully ahead of the service sector ISM number.  As if
the market was waiting for a reason to buy dollars, the greenback skyrocketed
after the stronger ISM report.  Increasing to 60.1 against expectations of a
weaker acceleration to 58.0, business activity in the service sector has
improved quite a bit in the month of February.  However, the dollar gave back
most of its gains through the rest of the US trading session as traders realized
that overall, even though the non-manufacturing ISM came in strong, the rest of
the data we have been seeing still suggest that the Fed is nearly done. 

This week, the US calendar is fairly light, especially in the
beginning of the week.  On Thursday and Friday however, two very important
releases are due for release – the trade balance for the month of January and
non-farm payrolls for the month of February.  The trade deficit is expected to
increase, but given that we have had only one month of funding deficiency as
measured by the Treasury International Capital report, the dollar may not react
too much to the report.  Payrolls on the other hand are expected to be extremely
strong given the low level of jobless claims over the past few weeks. 

In the meantime, the market’s primary focus will be on the
five central banks meeting to decide on interest rates.  The Bank of England,
Bank of Japan, Bank of Canada, Reserve Bank of New Zealand and Australia will
all be announcing interest rate decisions.  Aside from Japan and Canada, none of
the other central banks are expected to make any ground breaking announcements —
the UK, Australia and New Zealand are expected to leave interest rates
unchanged.  The Bank of Japan will most likely do the same, but after recent
comments this week, some traders are expecting the central bank to possibly drop
quantitative easing.  The Japanese will also be releasing their monthly report,
which will most likely build on their desire to start tightening monetary
policy. 

As for Canada, they are expected to increase interest rates
once again.  With the Loonie trading at 14 year highs against the US dollar and
oil prices rising once again, the rate hike by the Canadian central bank will
only fuel more gains in the CAD.  With so many major central banks meeting and
the US releasing two key pieces of economic data, we are expecting a lot more
volatility in the week ahead and for traders to focus even more closely on other
central banks that will be tightening monetary policy this year.

Euro

Despite a brief intraday dip, the EUR/USD has held onto most of its gains from
the prior day.  Trichet’s relatively hawkish comments yesterday have cemented
the ECB’s role as one of the next major central banks to raise rates in the
second quarter.  Economic data released are once again encouraging with the
region’s service sector PMI rising from 57.0 to 58.2.  Improvements were seen in
France and Italy, but the index for Germany fell modestly from 58.1 to 57.8. 
Fourth quarter GDP growth remained unchanged at 0.3 percent due to weak exports
and domestic consumption.  However, GDP is always seen as a backward looking
indicator. 

The ECB has already made known their belief that growth will
be accelerating this year.  In the week ahead, there are still a number of
important Eurozone economic indicators to watch for including retail sales,
German factory orders, industrial production and current account balance along
with French industrial production and Italian GDP.  Look for more signs of
stronger growth and hawkish comments to continue to fuel gains in the Euro.  

British Pound

After Thursday’s strong rally, the British pound extended its gains Friday
thanks to a sharp rise in the service sector PMI report.  The index jumped from
57.0 to 58.9, which follows yesterday’s strong construction sector PMI report. 
Despite the stronger data though, most of the gains are really attributed to
dollar weakness rather than pound strength.  Although the highlight next week is
the Bank of England rate decision.  The fact that the BoE is not expected to
make any moves and because they do not make any comments when leave rates
unchanged, the market may choose to focus more on the other pieces of data due
out next week.  We are expecting the BRC retail sales report, industrial
production and trade balance for the month of January.  

Japanese Yen

Mixed economic data released last night caused some traders to worry about when
the Bank of Japan may actually be dropping their quantitative easing policy. 
Even though core national CPI came in stronger than expected in the month of
January, growth in consumer prices in Tokyo for February was slower than
expected.  Household spending also took a surprisingly sharp dive while the
jobless rate edged higher.  The market was really looking for strength across
the board and the fact that the data failed to deliver prompted a strong
sell-off in the Japanese Yen.  This has pushed expectations for an interest rate
hike out to April instead of March.  Tighter monetary policy however is
inevitable, so this rally in USD/JPY could be nothing more than a retracement.  

Kathy Lien

Kathy Lien is the Chief Currency Strategist at

Forex Capital Markets. Kathy is responsible for providing research and analysis
for DailyFX, including technical and fundamental research reports, market
commentaries and trading strategies. A seasoned FX analyst and trader, prior to
joining FXCM, Kathy was an Associate at JPMorgan Chase where she worked in Cross
Markets and Foreign Exchange Trading.