In the context of fundamental currency analysis, we usually talk about inflation, interest rates, economic growth, politics, etc. But perhaps these variables mask some deeper "truth" in forex, specifically that there is some ultimate "force" guiding the decision-making processes of forex traders. What we are really talking about here is comfort with risk. Especially in the medium-term (the short-term consisting of hours and defined by randomness and the long-term consisting of years and defined by relative changes in the money supply), investors are constantly re-evaluating the level of risk that they want to assume.

The currency pair with the most market moving data next week is the British pound.  The Bank of England has an interest rate decision scheduled while the UK will release their industrial production and trade balance reports. Given the repeated disappointments in the PMI numbers, we now understand why the BoE has been reluctant to raise interest rates.

In contrast to the US, Japan has a very busy economic calendar next week with the Eco Watchers survey, machine orders, trade balance, corporate goods price index, consumer confidence and industrial production due for release.  This could lead to some yen driven price action, which is something that we haven’t seen in a while.

The Euro has weakened modestly against the US dollar following a surprising drop in German factory orders.  For the sixth month in a row, factory orders have been negative, which comes in sharp contrast with the stronger manufacturing PMI report released earlier this week. According to Goldman Sachs, European Banks may have to raise as much as EU90 billion euros to restore their balance sheets.  On Thursday, ECB President Trichet had his chance to engineer a new trend in the Euro.

- Euro: No Bias Equals No Action 
- British Pound Faces BoE Rate Decision

Will the G8 Meeting Impact the US Dollar?

In a move that will shock some investors but please others, the European Central Bank has raised its benchmark interest rate by 25 basis points, to 4.25%. On several recent occasions, Jean-Claude Trichet had alluded to the possibility, in connection to soaring inflation. Critics, including several politicians, have countered that the ECB should also be cognizant of the macroeconomic picture in Europe, which is faltering amid the global credit crunch. But such naysayers should remember that the ECB is mandated to maintain price stability, rather than to explicitly facilitate economic growth. In any event, this move certainly throws a wrench into the forex markets.

Volatility, the perennial enemy of the carry trade, has returned with a vengeance. The US stock market, a proxy for global risk appetite, has fallen significantly (nearly 20%) over the last six months, a trend that has accelerated over the last two weeks. By no coincidence, the Japanese Yen and Swiss Franc have rallied dramatically over the same time period. On one hand, currency trading is seemingly becoming more cut-and-dried, as correlations strengthen between different sectors of the global capital markets and specific currencies. The respective inverse relationships between the Dollar and oil, and between the Yen and US stocks, have been particularly strong of late.

The first half of 2008 has come to a dramatic end, and it's official: China's stock market was the world's worst performer, finishing down 48%. Ironically, some analysts believe this may be a harbinger for a faster appreciation of the Chinese Yuan. While the global credit crisis cannot be completely disentangled from the Chinese macroeconomic picture, certain conclusions can be drawn that are specific to China. In a nutshell, the party may be over. Inflation has surged to a 10-year high, economic growth is slowing, and stocks are facing a prolonged bear market. The Chinese government will likely continue to bide its time so as not to disrupt the Olympics. After the conclusion of the games, however, the Central Bank may begin aggressively hiking rates in order to tame inflation.