Currency and equity traders ignored the 0.1% decline in U.S. consumer spending in the month of September because the data could have been much worse. Between the drop in consumer confidence, sluggish job growth and slide in Johnson Redbook sales, Americans could have cut their spending more significantly last month. Instead, excluding automobile and gas purchases, retail sales rose 0.4%, up from 0.1% the previous month and the key control component rose 0.5%, which was better than expected.

However the overall level of spending is still very weak and should reduce Q3 GDP growth. Demand contracted for the first time since March and excluding gas purchases, dropped for the first time in 11 months. Investors were braced for a weak number but after today’s report, the U.S. could be poised for a back-to-back decline in retail sales in the month October. Today’s report shows how weakly positioned the economy was before the U.S. government shutdown and unfortunately conditions were only worsened by the dysfunction in Washington. At the same time, producer prices dropped 0.1%, which was also the first decline since March. On an annualized basis, PPI growth slowed from 1.4% to 0.3%, its weakest level since October 2009.

So while the dollar held onto its gains after the retail sales report, it will be very difficult for the Federal Reserve to ignore the lack of inflation and weak consumer spending. Despite a 0.4 percentage point decline in the unemployment rate between June and September, the third quarter was tough for the U.S. economy and while the Federal Reserve is not expected to alter monetary policy tomorrow, their description of the economy could be less optimistic. September numbers are the last pieces of data not affected by the government shutdown and for the next 2 months, investors and the central bank will discount every incoming economic report. When the Fed met in September, they said the housing market was strengthening and the labor market is showing further improvement but unfortunately both parts of the economy have deteriorated since then. In the FOMC statement the central bank could acknowledge the recent weakness and say the recovery was set back further by the government shutdown and this could be enough to solidify expectations for tapering in 2014 versus 2013.

Yet many investors may be wondering if all of this is already discounted by the market and is the reason why the dollar shrugged off the U.S. retail sales report. Since the last central banking meeting, investors have had plenty of time to price in a delayed move by the Fed especially during the prolonged shutdown. In the past 2 months, the dollar declined more than 4% against the euro and Swiss Franc and over 5% against the Australian and New Zealand dollars. At 1% the sell-off in USD/JPY is modest in comparison, but investors still sold dollars against all of the major currencies. So yes, investors have positioned for no tapering this year but given the significance of the FOMC announcement, we still expect the dollar to react to the central bank’s tone but the move in the dollar should be limited to less than 1% against all pairs.