Dollar Shrugs Off Weak Data as May Indicators Signal Bottom

The news flow in the last 24 hours has been decidedly negative with US retail sales falling more than expected, relations between China and the US souring further and Germany slipping into recession. Yet investors were unfazed with stocks ending the day flat and USD/JPY recovering earlier losses. In the US, consumer spending dropped -16.4% in the month of April, a record decline for retail sales. Clothing sales were down -78%, electronic sales were down -60% and furniture purchases fell -58%. This follows an -8.7% drop the previous month. Yet stocks and USD/JPY recovered initial losses because many feel that the worst is behind us for now. States are reopening in May, which should help spending so its completely feasible for retail sales to rise this month. In fact, based upon the recovery in the Empire State manufacturing index, which rebounded to -48.5 from -78.2 and against expectations of -60, a near term bottom may be in place – or at least that’s what market participants are hoping. The University of Michigan consumer sentiment index confirms this outlook as it rebounds from 71.8 to 73.7 in May. However if President Trump continues to threaten China, it will be very difficult for stocks to bottom.

Meanwhile Germany is the first of many countries to report official recessions – growth contracted significantly in the UK in Q1 and this quarter’s numbers are expected to confirm that they have fallen to the same fate. On Sunday night, Japan is expected to report negative Q1 growth and with the economy contracting -1.8% in Q4, recession will have also arrived. It is hard for investors to be optimistic in light of these reports especially as President Trump threatens to “cut off the whole relationship” with China. Considering the US’ reliance on China for chip and pharmaceutical supplies, no one wins in US-China cold war.

Even though Germany fell into recession, euro was the best performing currency on Friday. Lockdown measures are easing across the region. Italy announced that it would allow free movement within the country from June 3rd barring specific local restrictions. Germany is loosening quarantine restrictions for travelers arriving from EU, Schengen Area and UK. The Baltics launched a travel bubble that would allow citizens and residents of Lithuania, Latvia and Estonia to travel freely within the region. Investors see all of these steps as a move in the right direction for the Eurozone and drove the euro higher in response. Eurozone GDP numbers were also in line and not worse than expected with GDP contracting -3.8% in the first quarter.

In contrast, sterling was one of the worst performers, falling more than 1 percent and we expect that to remain the case in the coming week. No UK economic reports were released today but Brexit talks between the UK and EU went no where this week. There was very little progress made and according to EU’s Barnier, he’s determined but not optimistic that there will be an agreement, adding that the UK is stepping up preparations for no deal. Like the US, we expect ugly UK labor market and consumer spending numbers next week.

All three of the commodity currencies traded lower with the New Zealand dollar leading the slide. New Zealand’s manufacturing PMI index plunged to 26.1 in the month of April confirming the Reserve Bank’s negative outlook and validating their latest decision to double Quantitative Easing. We expect similar weakness in next week’s services and retail sales figures. Chinese data was also weak, putting pressure on Aussie with industrial production and retail sales falling in the month of April. The Canadian dollar will be in focus next week with inflation and retail sales numbers scheduled for release.