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Market tests G7 resolve on USD weakness/EUR strength

The market has so far largely ignored the G7s shift in currency language, which implicitly called for a stronger USD and a weaker EUR, with EUR/USD set to close the week at the same level as before the G7 statement. True, EUR/USD is finishing the week well below its highs after a vicious shake-out on Friday, but that appears to be more the result of excessive long EUR/USD positions from very high levels. US dollar sentiment remains weak and I continue to expect another try to take out the 1.6000 level next week. I look to build EUR/USD long positions between 1.5640/1.5740 on remaining weakness, and to take profit on strength between 1.60-1.61. EUR/USDs upside is in jeopardy if we see a break below trendline support at 1.5620/30. Eurozone officials will continue to complain if the EUR appreciates further and their verbal intervention seems likely to continue to unsettle short-term traders, offering additional opportunities to buy EUR/USD on dips. But I would note US Tsy. Sec. Paulsons post-G7 press conference comment in which he cited the shift in FX language as an acknowledgement of market changes, rather than a threat of intervention. Until the US appears on board for intervention to stem the USD decline, EU officials will be on their own. The risk of unilateral European intervention is not small and increases greatly if EUR/USD breaks above 1.6000, which is why I recommend taking partial profit on EUR/USD longs above 1.6000 at the minimum.

USD/JPY and the JPY-crosses have traded directly higher in line with gains in other risky assets like stocks and are representative of decreased risk aversion. As Ive suggested above, I dont expect the rebound in risk appetites to be sustained very much longer, with the likely catalyst weak US housing data next week. Concerning the G7 statement, the gain in EUR/JPY is an even greater in your face to EU complaints, with EUR/JPY having gained around 5 yen since before the G7 statement. If the Europeans are concerned about the strength of the EUR against the USD, theyre even more concerned about the strength of the EUR against Asian currencies, of which the JPY is the most obvious. From Japan, exporters are increasingly likely to be selling USD strength into the 105.00-107.00 area, suggesting strength seen this week may be the extent of the recovery in USD/JPY. A daily close back below 103.00 would be a sign of a rejection. EUR/JPY has significant trendline resistance drawn off the highs dating back to last July and a break above 165.50 would be needed to see gains extend further. The whole outlook for a top in USD/JPY, EUR/JPY and other JPY-crosses hinges on risk appetites turning back to risk aversion, which will require a piece of negative real-world news.

Key data and events to watch: Bank of Canada rate decision

On Tuesday morning, the Bank of Canada will announce its interest rate decision. The market expectation is for a 50 bp rate cut, from 3.50% to 3.00%, with a small minority favoring only 25 bps to 3.25%. Given the ongoing deterioration in the US and the expectation that it will last longer than expected, with greater negative implications for Canadian growth ahead, Im inclined to expect 50 bps of easing. Without a doubt, Canadian data has held up significantly better than would normally be expected, but recent reports have shown a sharp turn to the downside and inflation remains benign. More than anything, the BOC rate decision is about insurancecutting more aggressively now to limit the ultimate downturn, which is still to materialize. In terms of the market reaction, I think the CAD will probably only weaken slightly going into the decision and seems poised to strengthen afterwards on the basis that additional rate cuts may not be needed.

US data begins on Tuesday with March existing home sales, Feb. OFHEO house price index, and the Richmond Fed manufacturing index, with declines expected all around. Wednesday sees only weekly mortgage applications. Thursday sees March durable goods orders, weekly initial unemployment/continuing claims, and March new home sales. Friday finishes with final-April Univ. of Michigan consumer sentiment. No Fed speakers are scheduled to address the economic outlook or interest rates due to the blackout period ahead of the April 30 FOMC meeting.

Eurozone data begins in earnest on Wednesday with March French consumer spending, but the preliminary-April manufacturing and services PMIs for France, Germany, and the Eurozone will be highlighted. Thursday sees April French business confidence and the April German IFO survey of corporate sentiment. Friday will see only March German import prices.

Japanese data begins on Monday morning with the Feb. Tertiary (Services) Industry index followed by the final Feb. Leading Economic Index in the afternoon. Wednesday morning sees only the March trade balance of note. Thursday morning sees only the Feb. All-Industry Activity index. Friday morning sees April Tokyo CPI and March national CPI reports.

UK data begins on Sunday at midnight local UK time with April Rightmove house prices. On Wednesday morning, the Bank of England minutes from the April 10 meeting, at which the MPC cut rates 25 bps, will be released along with BBA mortgage lending data for March. Thursday morning sees March retail sales and the CBI (Confederation of British Industry) quarterly industrial trends survey. Friday finishes with the advance 1Q GDP estimate, forecast to show a 2.6% YoY increase, down from the prior 2.8%.