Dollar Broadly Lower, FOMC & Carry Trades Watched

Dollar was broadly lower last week as markets readjusted over-expectation on the chance of rate hike from Fed and renewed concern of credit crisis. Indeed, the odds of a 25bps hike in this week's FOMC meeting, as implied by interest rate futures, dropped sharply to a slim 8% chance after a series of disappointing economic data last week. Elsewhere in the markets, rate gap and expectation remained the dominant force with Aussie and Kiwi climbing most while the Japanese yen was broadly lower but the yen regained some grounds towards the end of the week as global stock markets tumbled. FOMC meeting will take center stage this week with a number of important economic data featured from US, Eurozone and UK.

On the data front, the data released last week provided little good news to the US economy. Headline PPI climbed sharply from 6.2% yoy to 7.2% yoy in May, beating expectation of 6.8%. Core PPI, on the other hand, was unchanged at 3.0% yoy. Housing starts dropped further to 0.975m annualized rate, a 17 year low. Building permits also dropped to 0.969m, annualized rate. NY State Manufacturing report dropped sharply from -3 to -8.68 in Jun versus expectation of -3.0. The index has been negative in four of the past five months as conditions remain restrictive. Philly Fed index also missed expectation and dropped further to -17.1 in Jun. Industrial production missed expectation and dropped -0.2% mom in May, with capacity utilization down from 79.7% to 79.4%. Current account deficit widened to -176.4b in Q1. Leading indicators climbed 0.1% in May. Jobless claims came in at 381k, slightly worse than expectation of 375k. TIC capital inflow recorded sharp rise to 115.1b in Apr.

Eurozone HICP was revised up to all time high of 3.7% yoy in May, up from prior month's 3.3%. Trade surplus in Eurozone came in at 2.3B in Jun. Germany ZEW dropped to a 15 year low of -52.4. Germany PPI climbed 1.0% mom, 6.0% yoy, above expectation of 0.9% mom, 5.8% yoy.

It was a big week for the pound. Headline CPI accelerated further to 3.3% yoy in May, with RPI climbed to 4.3% yoy, RPI-X climbed to 4.4% yoy. With inflation above 3.0%, BoE Governor King was triggered to write an open letter to Chancellor Darling. In the letter, King explained that oil and food prices, which alone account for 1.1% of the 1.2% increase in CPI since Dec, was the major driving factor in the current surge in consumer inflation. He noted that he expected a sequence of open letter over the next year or so. However, the overall tone was much less hawkish than expected. King noted that the path to bring inflation down to the bank's 2% target was "uncertain" even though CPI may exceed 4% this year. This disappointed the markets who has been expecting King to sketch a clear plan.

BoE minutes released showed an 8-1 vote too keep rates unchanged in the Jun meeting. Blanchflower was the sole dissenter voting for a 25bps cut. Most members believed that short term inflation outlook has worsened further and medium term inflation risks have moved further to the upside. If there were a serious threat to medium-term inflation expectations then a preemptive rise in rates would be appropriate," but after all, they still believe that a slowdown in the economy is enough to bring CPI back to the 2% target in medium term. The minutes also explicitly said that there was no case of a cut because of the inflation risks.

UK retail sales grew 3.5% mom in May, the most since 1986, pushing yoy rate to 8.1%, much stronger than consensus of -0.1% mom and 4.1% yoy. The data argued that UK consumer spending is still robust despite sluggish rate growth and inflation. Also, the data lifted some hope for BoE to raise rate to curb the persistently high inflation but it remains premature to draw conclusion based on just one piece of data. CBI industrial survey surprised on the upside by turning positive to +1 in Jun.

BoJ minutes released noted that the board members are fully aware of the risks on both growth and inflation, but there is little chance to change policy stance in the near future. Japanese Tertiary Industry index climbed 1.8% in Apr. All industry index climbed 0.8% in Apr.

SNB left three-month Libor unchanged at 2.25-3.25%, with mid point at 2.75%. The accompanying statement noted that there is a general increase in inflation since "the global economy remains robust and the price of oil has continued to climb" even though economic activity slowed down. Financial markets are "less turbulent". Real GDP forecasts in 2008 was unchanged at 1.5-2.0%, but inflation forecast is up to 2.7% SNB expected that with current Libor rate of 2.75%, inflation will ease back to 1.7% in 2009 and 1.3% in 200. Swiss retail sales climbed 2.4% mom in Apr, above expectation of 2.0%. ZEW index deteriorated further from -60.4 to -63.8 in Jun. Combined PPI climbed 1.2% mom, 3.9% yoy in May, above expectation of 0.9% mom, 3.6% yoy. Industrial production dropped -9.3% qoq in Q1, rose 4.3% yoy.

Canadian headline CPI accelerate for the second consecutive month, and at a much faster than expected pace, from 1.7% yoy to 2.2% yoy in May. Though, core CPI remains unchanged at 1.5%. The data provided the solid bullet for BoC to kept rates on hold last week and is supportive to BoC to refrain from further rate cut in view of rising inflationary pressure. Retail sales report was solid which saw ex-auto sales jumped by 1.1% in Apr, much better than consensus of 0.7%. Headline sales rose 0.6% mom, inline with expectations. Leading indicators climbed more than expected by 0.2% in May.

RBA meeting minutes said that "on current policy settings, the necessary moderation in demand is likely to occur. This is taken as a signal that RBA is comfortable with the current policy stance and reduced the chance of another hike in the near future.