US Dollar Trades Higher on Fed Comments and Retail Sales

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Daily FX Market Roundup 10-15-12

US Dollar Trades Higher on Fed Comments and Retail Sales
EUR: Held Back by Rise in Spanish Yields
GBP: All Eyes on CPI
AUD: Look for Clues on Further Rate Cuts from RBA
CAD: Lower Oil Offsets Stronger Data
NZD: Service Sector Activity Slows
JPY: Driven Lower by M&A Flow

US Dollar Trades Higher on Fed Comments and Retail Sales

Better than expected economic data drove the U.S. dollar and U.S. stocks higher. In recent months, good U.S. data has been more positive for risk than the greenback but this seems to have changed with today’s retail sales report as the dollar appreciated against all major currencies. While this shift may not last for long, continued uncertainty in Europe has certainly made it hard for investors to buy the euro. Even stronger Chinese trade numbers and U.S. consumer spending numbers were not enough to lift the currency. Federal Reserve officials can breathe a lot easier after the strong retail sales report. Between the 1.1% increase in retail sales last month and the upward revision to spending in August, we are now looking at a solid rebound in GDP growth in the third quarter.

A number of Federal Reserve officials spoke over the past 24 hours. On Sunday, Bernanke gave a seminar in Tokyo where he said Fed easing should boost the speed of growth, job market gains, trade and the performance of emerging economies. He defended the central bank’s actions against critics in other countries who blamed the Fed’s policies on slower growth in their local economies by saying that while he is sympathetic to nations facing volatile capital flows, he believes there will be no net cost to emerging economies. Despite the improvements in the labor market, Bernanke still feels that the recovery has been frustratingly slow and inflation has been generally subdued. The consistency in his comments suggests that the head of the Fed has not been swayed by the improvements in U.S. data. Fed Presidents Dudley, Lacker and Bullard also spoke this morning and comments from all 3 central bankers suggests that they have grown less not more willing to ease again.

Over the past month, there have many signs of improvements in the U.S. economy but each piece of positive data has been eyed with skepticism. The drop in the unemployment rate for example was inconsistent with the pace of growth in non-farm payrolls while lower claims was largely attributed to reporting issues from one state. It has been hard for the Federal Reserve and investors to believe that the U.S. recovery is gaining momentum but the improvement in retail sales over the past 2 months is a clear sign of stronger economic conditions. The improvement in the labor market and rise in stocks has made consumers more optimistic and more willing to spend. Excluding food and energy costs, which can be volatile, retail sales still increased 0.9%, more than double analyst expectations. Details of the report show a sharp increase in online shopping, purchases of electronics (iPhone), food and beverages.

For the Federal Reserve, the back to back improvements in U.S. data will definitely lead some investors to consider the possibility of an earlier withdrawal of monetary stimulus by the central bank and tomorrow’s consumer price report will play a role in shaping those expectations. While today’s retail sales report is very encouraging, one month worth of improvements in the labor market is just not enough to alter the central bank’s cautious outlook for the U.S. economy. With millions of Americans still unemployed, their work is far from done. Aside from retail sales, we also had the Empire State Manufacturing Survey released and according to the report, conditions in the NY region improved slightly this month with index rising from -10.41 to -6.16. This is the third straight month of contracting activity, but the improvements in the manufacturing sector is still consistent with a stronger recovery. Aside from CPI, industrial production and the Treasury International Capital Flow report are also scheduled for release on Tuesday.

EUR: Held Back by Rise in Spanish Yields

European currencies did not benefit from the rally in U.S. equities. The euro, British pound and Swiss Franc ended the North American trading session unchanged against the greenback. It is a quiet day when Switzerland in the only European nation with any meaningful economic data on the calendar. Swiss producer prices rose by 0.3% in the month of September, which was faster than anticipated but slower than the previous month. Part of the reason why euro failed to rally is because 10 year Spanish bond yields rose 19bp today to 5.77%. The pressure is heating for Spain to ask for a bailout. We don’t think that this will happen before the October 21st regional elections but afterwards, its fair game because based on the rise in Spanish yields investors are not satisfied with Spain’s economic reforms. Greek bond yields on the other hand fell to its lowest levels since the country’s debt was restructured in March. Germany is clearly throwing her support behind Greece remaining in the euro. Angela Merkel made this clear during her visit earlier this month and today, German Finance Minister Schaeuble confirmed that a Greek default “will not happen,” dismissing any speculation that Greece will be forced to leave the euro. European leaders are meeting in Brussels later this week and while no decisions are expected on Spain, there is a small possibility that a deal could be reached for Greece, unlocking much needed bailout funds for the country. Greek Prime Minister Samaras said today they will receive their next bailout tranche soon which will lower the country’s euro exit risk. The German ZEW survey of economic sentiment is scheduled for release on Tuesday along with a Spanish T-bill auction. Restoring confidence in European assets is the key to ending the region’s debt crisis.

GBP: All Eyes on CPI

This is a busy week in the U.K. with a number of market moving event risks on the calendar. The action begins tomorrow with the monthly consumer and producer price reports. As an inflation fighting central bank, CPI is always an important release for the British pound. This is particularly true for this week’s release because the Bank of England is widely expected to be the next central bank to ease. If consumer prices growth slows the case for more Quantitative Easing hardens significantly, which will be bearish for GBP/USD. However if CPI rises by more than expected, then the BoE may keep policy unchanged for longer than anticipated because annualized inflation is still running above their 2% target. A number of BoE officials have already expressed concerns about inflation being stickier than expected which suggests that not everyone is behind the idea of more stimulus. PPI is normally released before CPI but in this case, they are published simultaneously. According to a survey from the British Retail Consortium, price growth slowed last month but the PMI reports show input prices increasing and output prices moderating in September. Rightmove house prices were released last night and the data shows home prices rising 3.5% in October. While the improvement is encouraging, it is inconsistent with the decline in prices reported by Nationwide and Halifax.

AUD: Look for Clues on Further Rate Cuts from RBA

The Australian and New Zealand dollars traded higher against the greenback thanks to stronger Chinese trade numbers while the Canadian dollar ended the day unchanged. Tonight is a big night for Australia with the minutes from the most recent Reserve Bank of Australia meeting scheduled for release. If you recall, the RBA cut interest rates by 25bp this month. The decision was not widely anticipated because economic data up to that point was not that bad. As a result, it will be interesting to see what pushed the central bank over the edge. Since then we know that the economy has taken a turn for the worse with manufacturing and service sector contracting more significantly. The more important question however is whether more is to come. If the RBA sounds extremely dovish, the AUD/USD will weaken as the case for further rate cuts harden. If the RBA indicates that this was an insurance move, the AUD/USD will rally because the market is already pricing in another 25bp rate cut next month. The New Zealand dollar shrugged off weaker service sector activity to end the day higher against the greenback. Consumer prices are due for release this evening and inflationary pressures are expected to accelerate. Better than expected Canadian data on the other hand was offset by lower oil prices, which prevented the CAD from participating in the rally. International Securities Transactions and Manufacturing Sales are scheduled for release on Tuesday but neither of these reports will have much impact on the Canadian dollar

JPY: Driven Lower by M&A Flow

The Japanese Yen traded lower against all of the major currencies on the heels of weaker economic data and news that mobile operator Softbank has agreed to acquire a 70% stake in U.S. based Sprint/Next for $20 billion. This is the largest ever foreign acquisition by a Japanese company and combines the #3 U.S. mobile carrier with the #3 Japanese carrier. While Sprint was in desperate need of cash infusion, the ultimate goal is to propel both carriers from number 3 to number 2 in their local countries. For the forex market, this transaction is a big deal because a large part of it will be in cash, which means a lot of Yen needs to be converted into U.S. dollars. Two years ago, a deal of the same size would have cost 10% more but the recent strength of the Japanese Yen has made this a much cheaper acquisition for Softbank. A deal of this magnitude also suggests that not all Japanese firms are strapped for cash. Nonetheless the economy in general continues to struggle with industrial production revised down to -1.6% from -1.3% in August. The export sector has been hit hard by the strong currency and we don’t expect this to change anytime soon. Over the weekend, Economy Minister Maehara talked about different ways Japan could stimulate the economy and said one way would be to buy foreign bonds.

Kathy Lien
Managing Director

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