Choppy U.S. Economic Data Keeps Volatility High

The dollar sold off this week as risky assets made a comeback. The sell-off was marked by strong economic data gains in China and Australia.

In addition to some favorable U.S. housing data, there are some signs that the U.S. economic data may be flattening out as the U.S. factory activity was better than expected. But economic data it remains choppy. Altogether G10 economic surprises were positive so investors took the opportunity to jump back into risk-on trades.

The euro recovered in line with equity market strength backed by a fall in risk aversion. In addition to the small rebound in macro risk, ECB comments provided support for the euro. On Thursday European Central Bank President, Jean-Claude Trichet, said a double dip was not in the cards, leading to speculation about the withdrawal of monetary stimulus.

The ECB's comments were, of course, bullish, suggesting that the ECB feels the economy recovery is improving at a comfortable pace. Consequently, the spread of the two-year U.S. and German generic government bond yields increased, favoring euro longs.

As expected the Swedish Riksbank raised its benchmark rate, known as the repo rate, to 0.75% from 0.50%. In a statement issued after the rate announcement Swedish central bankers indicated, "Inflationary pressures are currently low, but are expected to increase as economic activity strengthens."

The central bank also signaled further hikes by indicating that the rates "need to be raised gradually towards more normal levels to attain the inflation target of 2% and create the right conditions for stable growth in the real economy."

A key theme emerging in Japan is the possibility of central bank intervention to stem currency appreciation. Intervention is unlikely as there has been very little communication between the central bank and the prime minister.

In addition history suggests that unilateral intervention in ineffective as the market tends to overwhelm the central bank. Economic trends in the U.S. will be the main driver and US data will drive interest rate spread and volatility.

Weekly Trading Recommendations

Stay short USD/JPY at current levels with a stop loss of 85.46 and a target of 83 over the next month. U.S. data remains mixed which will likely drive volatility.

Stay short EUR/USD at current levels with a stop loss of 1.3021. This trade has given up much of the profit gained over the past two weeks. Euro still faces headwinds with more downside risks but over the short-term will most likely stay range-bound, remaining between 1.25 and 1.29.