Dollar: Stronger Spending and Claims Makes Fed Decision Easy

The U.S. dollar is trading lower against most of the major currencies this morning, but is slowly recovering its earlier losses thanks to better than expected economic data. Like last week’s non-farm payrolls report, this morning’s retail sales and jobless claims numbers will harden the Federal Reserve’s commitment to tapering asset purchases. Before today’s releases, central bank officials made it clear that a significant deterioration in the economic outlook would be needed to change the course the course of tapering. So unless retail sales fell by 1.5% or more, we can expect another $10 billion reduction in monthly bond purchases.

Thankfully reducing stimulus won’t be a tough decision for Janet Yellen next week. For the first time since November, retail sales rose 0.3%. The dollar’s reaction to retail sales would have been stronger if there was a smaller downward revision to January data. However even though spending was revised lower the previous month, the fact that sales turned positive after two months of contraction is good news for the U.S. economy and should help sustain demand for U.S. dollars. The rebound in sales tells us that spending is finally recovering after a brutal winter and will most likely improve further in March.

The big surprise was in jobless claims, which dropped to its lowest level in 4 months. After last week’s improvement, economists were looking for weekly claims to snapback but instead they declined to 315k from 324k. With the 4-week moving average also falling to 330k from 336k, the Federal Reserve has every reason to believe that the labor market continued to improve this month. Combined with the 0.9% rise in import prices, the central bank will not only continue removing stimulus and drop the unemployment rate threshold but they should sound more optimistic about the outlook for the U.S. economy.

With no Tier 1 U.S. economic reports scheduled for release between now and next Wednesday’s FOMC announcement, we expect the dollar to remain bid ahead of Janet Yellen’s very first monetary policy meeting as Chairwoman. Unfortunately it doesn’t seem that there is enough momentum in the market for a significant dollar rally before the FOMC meeting. U.S. 10 yields may have to rise to 2.9% for USD/JPY to hit fresh 1-month highs. As for the euro, today’s reports should not pose a major threat to rally if the currency is supported by risk appetite.

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