Daily FX Market Roundup 10.14.15

Dollar Crushed by Retail Sales, What’s Next for USD/JPY

Investors sold U.S. dollars aggressively after this morning’s abysmal U.S. retail sales report. Not only did consumer spending rise by only 0.1% in September but spending in August was revised down to 0% from an initial 0.2% forecast. Excluding auto and gas, there was no growth in retail sales and excluding only autos, spending dropped -0.3%. On top of this, producer prices fell by -0.5%, the steepest decline this year. With inflation falling and consumer spending stagnating, it will be very difficult for the Federal Reserve to pull the trigger this year. The economy could regain momentum in November or December but a significant turnaround would be needed to shift market expectations. The decline in the dollar reflects the growing belief that the first rate hike will be in 2016 and not 2015. Fed fund futures are now pricing in 29% chance of a rate rise in December versus 35% before the retail sales report. At the start of this week, we warned that there could be more pain for the greenback and tomorrow’s consumer prices report should add to the dollar’s troubles. Aside from the drop in PPI, gas prices declined in the month of September which signals a potential downside surprise in CPI. Nonetheless according to the Beige Book, the economy continued modest expansion mid August to early October.

The sell-off in the dollar broke the triangle pattern in USD/JPY. For the past 7 weeks, the currency was trading in an increasingly narrow range that is usually a precursor to a major breakout. Today’s retail sales report was not only the perfect catalyst but also weak enough to trigger a big move in the currency. The question now is whether the downside momentum can be sustained. There’s no question that USD/JPY broke out of its symmetrical triangle pattern but it has yet to close below the sloppy descending triangle pattern. USDJPY needs to drop and close below 118.25 for both patterns to be broken. Yellen would need to vocally admit that 2015 tightening is off the table for USD/JPY to hit 116. Pressure is also mounting on the Bank of Japan to ease with the Japanese government cutting its latest economic forecasts.

The euro is on a tear despite weak Eurozone data and a persistent decline in German bund yields. Eurozone industrial production dropped 0.5% in the month of August. While this decline was right in line with estimates it doesn’t diminish the fact that manufacturing activity received zero support from a weaker currency and lower energy prices. The strength of EUR/USD clearly comes from the weakness of the greenback and a short squeeze in the currency pair. If EUR/USD closes above the May high of 1.1467, 1.1500 becomes the main level of resistance. However the higher the euro rises, the more problems it creates for Europe’s economy and the greater the pressure it puts on the ECB to ease again.

Sterling soared on the combination of GBP strength and USD weakness. Unlike the euro, the rally in the British pound was supported by U.K. data. Jobless claims increased in the month of September but weekly average earnings continued to grow and most importantly the unemployment rate dropped to its lowest level since 2008. While we wish that the data was overwhelmingly positive, the report was good enough for GBP/USD to erase all of yesterday’s and put the pair on track to test 1.55. Bank of England officials have pointed to wage growth as a primary reason for their need to be vigilant with monetary policy so the latest report justifies the increase in the currency. However the central bank is still in no position to raise interest rates.

The best performing currency today was the New Zealand dollar, which rose as much as 2% against the greenback intraday to a 3 month high. Aside from U.S. dollar weakness, NZD/USD benefitted greatly from Reserve Bank of New Zealand Governor Wheeler’s latest comments. While he warned that further easing may be necessary, his optimism about recent economic indicators and concern about rising property prices suggests that there is very little urgency to act. The recovery in dairy prices has gone a long way in restoring the central bank’s confidence and reversing the market’s expectations for RBNZ policy. There’s no doubt short covering had a lot to do with the currency pair’s strength.

The Australian dollar also traded well today but news that news that Westpac, one of Australia’s largest banks raised its variable mortgage rate by 20bp ups the pressure for the Reserve Bank of Australia to lower interest rates next month. This hike though small poses a major risk to the housing market and the economy especially if other banks follow suit. Even before this announcement, the market had priced in a 50% of chance a rate cut in November however with this move, the central bank will feel compelled to act to prevent a loss of policy control. The Australian dollar is in play tonight with the country’s employment report scheduled for release. Given the drop in the employment component of manufacturing, service and construction sector PMI, the risk is to the downside for the report.

USD/CAD was primarily hit by U.S. dollar weakness. While oil prices held steady, the currency pair rejected the 1.30 level. For the time being it appears that 1.29 to 1.3075 appears to be a comfortable trading range for the pair.

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