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- Fed attempts to bolster USD, ECB flummoxes

- May NFP reveals the glass is half empty

- Bank of Canada rate decision on Tuesday

- Update from Downunder (AUD & NZD)

- Key data and events to watch next week

Fed attempts to bolster USD, ECB flummoxes

The new month got off to a rollicking start (yes, Im being sarcastic) with Fed Chair Bernanke on Tuesday addressing USD weakness in prepared remarks to the International Monetary Conference. Bernanke explicitly noted that the Fed, "in collaboration with our colleagues at the Treasury," was carefully monitoring currency markets, the important points being that Treasury was included and that the weak USD was on the Feds radar screen. Bernanke noted that USD weakness had an impact on inflation and inflation expectations and voiced a preference for a "strong and stable dollar." His remarks caught the market off guard, but his message was ultimately deemed to be potentially significant by many market participants and a USD buying spree ensued. By early Thursday morning, the USD was on the verge of breaking higher, with the USD index breaking up over trendline resistance dating back to last August, and higher out of the Ichimoku cloud. But the moves were not to last.

On Thursday morning, just after better than expected weekly jobless claims saw the USD push to new highs below 1.5400 EUR/USD, ECB Pres. Trichet began his press conference with hawkish rhetoric warning that greater inflation risks prevailed. Before he finished, Trichet would drop the bombshell that the ECB was very likely to raise rates at the July ECB meeting, which markets had not been expecting. Over the next few hours EUR/USD soared from 1.54 to finish the day near 1.56 on massive short-covering from a thoroughly confused market. The icing on the cake came on Friday with weaker than expected May NFP employment data out of the US, adding USD selling pressure to EUR buying pressure. EUR/USD pressed higher to within reach of recent highs at 1.5800/20 by Friday afternoon. But the lasting impression in the Forex markets was one of a lack of policy coordination across the Atlantic on USD weakness/EUR strength and leaving the Fed exposed to credibility issues. The higher interest rate signal from the ECB, with its implications for EUR strength, suggests the ECB may now be more willing to tolerate a higher EUR than previously thought.

This is a dramatic time in currency markets, as markets were slowly coming around to the view that the USD had likely bottomed, and while unlikely to rally sharply, would at least stop weakening. Those expectations are now seriously damaged and the potential for a crisis of confidence in the USD is rising as a result. There are many variables at work, not the least of which is that an ECB rate hike is not a done deal yet, though comments from ECB officials Weber and Bini-Smaghi on Friday suggested it was. Trichet suggested any rate hike would be small, leaving the impression that it would be a one-time hike rather than the start of a new tightening cycle. From the US side, we have numerous Fed speakers on tap next week, including NY Fed Pres. Geithner and Chairman Bernanke, along with Treasury Sec. Paulson, who will have an opportunity to echo and/or amplify their commitment to preventing further USD weakness. The big question, though, is whether Forex markets will buy into US efforts to support the USD again absent concrete action in the form of higher US interest rates or market intervention.

We are on the cusp of a renewed phase of USD weakness, exacerbated by spiking oil prices and weaker labor reports. There are reasons to believe that oil price gains might be based on short-term positioning moves, but the trend has been relentless. Traders need to reckon with fresh USD weakness if the recent double top at 1.5810/20 is broken on a closing basis. Perceptions of 1.60 as the maximum EUR/USD level have been severely weakened after the ECBs rate shift, and the feeling is growing that the ECB might be prepared to allow for a higher EUR as another way to combat inflation, so strength beyond 1.60 may still be in the cards.

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