The surprise slowdown in U.S. retail sales forced the dollar to give up part of its gains this morning. Overnight the greenback enjoyed a nice rally but with consumer spending rising by half of what economists anticipated for the month of June, it may be difficult for the currency to remain positive in today’s trade against some currencies such as the euro, British pound, Canadian and New Zealand dollars. While we don’t expect major losses in the dollar on the back today’s news, especially against the Yen this data gives the central bank reason to maintain a more cautious approach. Few will argue that the Federal Reserve is getting ready to taper this year, but how they choose to do so could affect the market’s reaction. The central bank could always taper less or pause after a one-off move, which would moderate the market’s reaction and give the economy breathing room while still moving in the direction of reducing overall stimulus.

U.S. retail sales slowed to 0.4% in the month of June, from downwardly revised growth of 0.5% the previous month. Excluding autos and gas, spending contracted for the first time in 12 months by 0.1%. These numbers indicate that consumer spending will contribute very little to GDP growth in the second quarter. The largest decline was seen in building materials but Americans also spent less on electronics, food and beverages, department stores and other miscellaneous items. Despite the pickup in job growth, consumer appetite has been muted and until we get a stronger recovery in consumption, the Federal Reserve will need to be very careful with how much stimulus they remove from the economy this year. Manufacturing conditions in New York on the other hand improved in the month of July. The Empire State manufacturing survey rose to 9.46 from 7.84, a sign that the sector is continuing to recover after contracting in May.

Today’s retail sales report will give Bernanke greater motivation to sound cautious and more dovish at his semi-annual testimony on the economy and monetary policy before the House on Wednesday and the Senate on Thursday. While we doubt that the Fed has changed their minds about tapering this year, Bernanke will spend most of his time in Washington reassuring Congress it will not send the economy into a downward spiral. To do so, he will stress that monetary policy will remain extremely accommodative and a rate hike is a long ways away. The specific comments may not deviate much from his speech last week but the two testimonies can be very market moving because tough grilling by Congress may force Bernanke to divulge more details on the Fed’s plan to tapering. Last week, Bernanke’s dovish tone sent the dollar tumbling and we were surprised by the magnitude of the dollar correction because we did not feel that Bernanke’s comments altered the timing for tapering and therefore did not warrant the sharp reversal in the greenback. Barring any surprise deterioration in U.S. data, we still believe the Fed will begin reducing asset purchases in September. With approximately 2 months before the next FOMC meeting, if the U.S. economy continues to recover, the central bank may become more vocal about their plans to prepare the market for a change in monetary policy and as that occurs, the process should revive the rally in the U.S. dollar.

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