The U.S. dollar continues to trade higher against most of the major currencies this morning with USD/JPY leading the gains giving investors hope that the currency pair is finally waking up to the rise in U.S. yields. Although the slightly softer weekly jobless claims report erased earlier losses in Treasuries, investors around the world have their eyes locked on the 3% target for 10 year yields. Yesterday’s FOMC minutes basically confirmed that there is enough support inside the central bank for a reduction in asset purchases this year. So as long as U.S. data isn’t terrible, it should only be a matter of time before yields test 3%. However, further moves beyond that rate could be limited because a) the market has had plenty of time to price in tapering this year and b) the Fed will do everything in its power to prevent a sharp increase in yields especially since U.S. data has been far from inspiring.

While the latest PMI numbers show a stronger recovery in the Eurozone and China, U.S. manufacturing activity expanded at a slower pace according to Markit’s PMI report. Jobless claims also rose to 336k from 323k while continuing claims hit 2.999 million, up from 2.970 million. Even with the increase, jobless claims remain at healthy levels with the 4-week moving average dropping to its lowest level since November 2007. Fewer firings may not translate into stronger hiring but for the Fed, this report won’t raise any new concerns about labor market activity. House prices grew at a slower pace in June but the increase was stronger than expected and the past month’s report was revised higher. The Fed sees a continued recovery in housing this year and today’s data confirms that. The dollar sold off slightly after these reports but is still trading strong against many of the major currencies.

The annual monetary policy symposium in Jackson Hole begins today and goes to Friday. We will be on the watch for comments from policymakers, but market-moving comments should be limited because Fed Chairman Ben Bernanke won’t be attending. Two months ago, he dismissed the significance of the meeting by saying, “There’s a perception that the Jackson Hole conference is a Federal Reserve system-wide conference; it’s not” which is why no fireworks are expected.

Meanwhile USD/CAD broke through the 1.05 level after retail sales dropped 0.6% in the month of June. Economists had expected a 0.4% decline and stripping out autos, they believed sales would be flat. Unfortunately core retail sales dropped -0.8% which was more than the headline report. Part of the decline in consumption can be attributed to the floods in Alberta but steep job losses and a recent downturn in Canadian data suggests that labor market weakness is indicative of a broader slowdown in Canada’s economy. On balance, retail sales are expected to provide a smaller contribution to GDP growth in Q2.

The euro failed to hold onto its earlier gains despite stronger Eurozone PMI numbers. According to the latest reports manufacturing and service sector in Germany expanded at a faster pace in the month of August, helping to boost activity in the overall region. Despite muted French PMI numbers, this was the first time that Eurozone manufacturing and service sector activity expanded together in 18 months. These improvements confirm that the Eurozone recovery is still underway even if there may be some pockets of weakness in the region. So while we still need to see additional improvements in PMI to call this a new trend, the data is moving in the right direction.

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