Currencies are on the move this morning thanks to the breakout in equities. Two out of the three U.S. composites opened above key technical levels, paving the way for stronger gains in high beta currencies. The Dow Jones Industrial Average breached 16k and the S&P 500 cleared 1800 for the first time ever. This price action reflects the market’s hope that the Federal Reserve will leave asset purchases unchanged for the rest of the year. In other words, Janet Yellen’s dovish views last week convinced investors that the Fed would not taper until 2014. While cheap money is good for equities, it is also important to realize that the only reason why the Fed would delay a reduction in stimulus is because economic activity is falling short of expectations, which is hardly a reason to be optimistic. This week’s U.S. retail sales report is also expected to show stagnation in consumer spending but investors are ignoring these risks and focusing instead on the support that another month or two of $85 billion in bond buying could provide to the economy. The outlook for the dollar today hinges on whether stocks are able to hold onto their gains because if they do, the dollar could extend its losses against high beta currencies.
The Treasury International Capital Flow report was the only piece of U.S. data on the calendar and as usual, its impact on the greenback was limited even though the data showed how much impact the U.S. fiscal showdown had on foreign demand for U.S. assets. According to the TIC report, foreigners sold $106.8B U.S. dollars in the month September, the largest amount since 2009. Investors did not respond aggressively because the outflow was concentrated in short term liabilities and changes in the banks own dollar denominated liabilities. Foreign demand for U.S. Treasuries increased by $25.5B that month, which was more than expected and up from net sales the previous month. High beta currencies continued to benefit from China’s reform policies as investors hope that more stability for China will mean long-term benefits for the global economy. As it will be years before we see the payoffs from China’s policies, in the near term, Federal Reserve Chairman Ben Bernanke’s speech this week, the FOMC minutes and U.S. retail sales reports will be the central focus for FX traders.
Even with Yellen’s dovish views, we know that most FOMC officials favor earlier tapering so when the minutes from the last Fed meeting is released, it could be less dovish which would be supportive of the greenback but unfortunately that would only be the case if retail sales turned positive in the month of October. If consumer spending declines for the second month in a row, policymakers will have to abandon their support to taper in December. According to other measures of consumer spending, retail sales last month was weak. Johnson Redbook reported a 1.2% decline in sales in October versus September and while the International Council of Shopping Centers reported a 4.1% year over year gain in chain store sales, this represented only a slight increase from the previous month’s 4.0% rise. So we don’t rule out the possibility of short-term pain in the dollar before long term gain. A number of Federal Reserve officials are also scheduled to speak including Ben Bernanke and as usual their views on monetary policy can affect the dollar by shaping the market’s expectations for Fed tapering.