- USD still falling, risk still rallying

- Price action beholden to EPS over next two weeks

- GBP rallies ahead of BOE minutes, 3Q GDP

- EUR strength a topic for Eurozone finance ministers

- Key data and events to watch next week

USD still falling, risk still rallying

The greenback lost fresh ground to near 14-month lows, as stocks, commodities and other risk assets continued their ascent, but the JPY emerged as the biggest loser on the week. As suggested in last week's report, JPY-crosses re-connected with risk appetites and saw some of their biggest gains in months after languishing for the last several weeks while the focus was on dollar weakness. With US Treasury yields sustaining recent gains, the JPY is likely to continue to act as the primary funding currency for risk speculators, perhaps giving the USD some breathing room, if only in USD/JPY. Corporate earnings are likely to remain the key driver (see below), however, and any dollar recovery is only likely on disappointing reports or economic data. Sentiment remains extremely USD negative, and dovish FOMC minutes reinforced concerns over the strength of the US recovery. More importantly for the USD, discussion among Fed officials over extending the size of the Fed's asset purchases (quantitative easing) added yet another reason to sell dollars. Markets appeared to be expecting the Fed to wind down its asset purchases, so the FOMC discussion came as a surprise. In specific pairs, USD/JPY gains over the 90.27 daily Kijun line shift the focus higher while that level holds, and strength over 91.50 is likely to trigger further gains to the 92.50/93.00 area initially. Positioning is still quite long JPY, and despite this past week's squeeze higher in all JPY pairs, we have to reckon with further short-covering in JPY-crosses still to come. EUR/USD has effectively tested the 1.5000 level, though barrier option interest at that level is still a tempting target. Strength above 1.5000 will have the market eying 1.5500 next, but we think the 1.5250/5300 will prove difficult. On the downside, 1.4750/1.4800 looks to be an important near-term support zone and a drop below there may signal that 1.50 has held as a medium-term top. GBP/USD has rallied back to just below the Ichimoku cloud (base at 1.6450/top at 1.6514) which is extremely thin and may be broken relatively easily. Strength above 1.65 is likely to target 1.6750/6800 initially, while a drop below 1.6220/50 likely signals this week's strength was overdone.

Price action beholden to EPS over next two weeks

With only 7% of the S&P 500 having reported thus far, the make-up of 3Q earnings looks eerily similar to 2Q results. Sales have practically been in line with low-ball estimates (+0.1% surprise) while the bottom line continues to outperform expectations (+18.1% better). This points once again to earnings growth via cost cutting and not earnings growth through organic means. Cost cutting, of course, can only last for so long and eventually EPS will have to be driven by a pickup in actual business activity. We remain cautious with regards to the potential of such a pickup given the dreadful state of the consumer balance sheet and the awful employment landscape. Given that, by our calculations, the consumer still needs to unwind roughly $500 billion in non-real estate credit to get back to sustainable debt/income levels and that unemployment will continue to rise in the first half of 2010 right through 10% makes this sort of organic growth questionable to say the least. This is the main premise behind our view that the current rally in equities is well overdone and a sharp short-term correction is looming. The next two weeks will paint a better picture of the current earnings landscape as we have 290 companies slated to report. As such, the price action in all markets will be beholden to the outcomes in this space. Given very strong inter-market correlations - with commodities, stocks, and yields all moving opposite to the US dollar - we could be setting up for a significant reversal in the recent trends. In other words, should earnings disappoint on the top-line, we would expect the US dollar to find a solid short-term base and see a significant pick-up in buying interest. Those likely to suffer the most on earnings disappointments are AUD and CAD as much of the near-term strength here (economic fundamental improvement notwithstanding) can be directly attributed to the euphoria in the commodities space. The gold bulls will also undoubtedly head for the exit.

GBP rallies ahead of BOE minutes, 3Q GDP

Sterling has been squeezed higher under a weight of short positions. Better UK labor data has softened the dismal economic backdrop in the UK but the trigger for the move was a report in the FT citing satisfied remarks from the FT's Fisher over the scale and impact of QE. From this the market inferred that QE may be on hold in November. In all probability the MPC is still undecided on the issue and the forthcoming releases of the Oct MPC minutes, Q3 GDP, retail sales and PSNCR are likely to be pivotal in determining whether or not sterling can retain its better tone. Alongside the dismal position of public finances, the release of much worse than expected US Q2 data was arguably responsible for much of the sour mood that has clouded GBP since the middle of the year. Data released during the past few months suggest that the production sector in the UK may be slipping back into recession and this has led to a median expectation for Q3 GDP of just +0.2% q/q (-4.6% y/y). Risk that this number could disappoint coupled with poor PSNCR data and the likelihood that the tone of the MPC minutes will remain cautious on the economic outlook implies that QE may be back on the table by the end of next week and sterling could be struggling to push higher. As a consequence cable is likely to hold a more cautious tone going into the new week. That said, good economic data would support the more constructive technical picture and could lead to another squeeze higher for the pound.

EUR strength a topic for Eurozone finance ministers

On Monday and Tuesday next week, Euro-area finance ministers will gather for a regular monthly meeting and officials' comments suggest EUR strength is likely to be a topic of discussion. Eurozone finance group chief Juncker indicated that he is not concerned about current EUR levels, but that further strength could undermine European recovery prospects. France's Lagarde has been the most vocal in calling for Euro strength/USD weakness to be addressed, but German Economics minister Guttenberg said that USD weakness was not a cause for concern for exporters. However, Eurozone exports fell by 5.8% m/m sa in August. This suggests that the Eurozone could be struggling to shrug off the constraints of its downturn in the face of the strength of the EUR. On balance, expectations are low that the conclave will produce any concrete results to stem the EUR's rise, but traders are likely to tread cautiously until the meetings are done and comments are out of the way. If so, EUR/USD may see some weakness early in the week, but blithe FX comments from finance ministers indicating continued laissez faire attitudes could be taken as a green light to keep buying EUR, leading to fresh gains from late Tuesday onward. More important, we expect risk assets to continue to be the main driver, with stocks setting the tone (see above). On the data front, the week ahead will bring the releases of PMI and the German IFO index. The market is expecting these indices to show that the Eurozone recovery remains on track. While the absence of inflationary pressures in the Eurozone suggest that these data will bring no change in the view that the ECB will not be hiking interest rates until well into 2010, good data should encourage risk appetite and thus support the EUR.

Key data and events to watch next week

The United States has a relatively busy agenda in the week ahead. The homebuilder sentiment (NAHB) index kicks things off on Monday while Tuesday is busy with producer prices and housing starts/permits. The key on Wednesday is the Fed's Beige Book, which provides tons of anecdotal information on the state of the economy. Thursday has the usual weekly jobless claims and the index of leading economic indicators. Existing home sales round out the week on Friday. There are some top tier reports due out in the Eurozone. Construction output gets the ball rolling on Tuesday while Thursday has the current account and French business confidence on deck. Manufacturing and services PMIs along with French consumer spending are due Friday. Of note as well is a meeting by the EU Finance Ministers next week who are expected to discuss EUR. Should the rhetoric with regards to concern about EUR strength intensify, expect the currency to come under considerable pressure. The UK also has some important releases. Tuesday starts the action with public sector borrowing data while Wednesday has the all-important BoE meeting minutes and the quarterly CBI industrial trends report. Retail sales highlight Thursday while GDP and home loan activity round out the week on Friday. Japan is busier than usual. Nationwide department store sales kick things off on Monday while Tuesday has the index of leading economic indicators and machine tool orders lined up. The trade balance is up on Wednesday and a weaker number should cast doubt on the recent JPY strength. Thursday closes out the week with the all industry activity index. Canada has a characteristically light but important week ahead. International security transactions are due on Monday while Tuesday brings wholesale sales, leading indicators and the Bank of Canada interest rate meeting. In terms of the BoC, we do not expect any change in the current 0.25% target rate but will be on the lookout for any commentary regarding Canadian Dollar strength. In the last go-around they said that persistent strength in the Canadian dollar remains a risk to growth so we will need to see something a touch more aggressive in order to see considerable CAD weakness. Friday ends the week with the key retail sales report. The action is limited down under. New Zealand kicks off the action with the performance of services index on Sunday. The RBA meeting minutes are due Monday while the Australian leading index and motor vehicle sales close things out on Tuesday.