No Reason for Fed to Doubt QE Call After Retail Sales and CPI

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Currency and equity markets continued to soar as unlimited liquidity from central banks fuel strong rallies in risk assets. Even USD/JPY joined the move, which tells us that today’s gains is not about how Quantitative Easing devalues the dollar but how low interest rates and cheap money will keep the party going for equities and by extension currencies. The EUR/USD reached a high of 1.3120 in early U.S. trading and is hovering not far from those levels after this morning’s U.S. economic reports. Consumer spending and consumer price figures were unfairly distorted by higher gas prices. Consumption and inflation increased in the month of August but if we strip out the gas component of both reports, demand and price pressures were muted. Unfortunately higher gas prices acts like a tax for consumers which bad news for the economy. The retail sales and consumer price reports give the Federal Reserve very little reason to doubt their decision yesterday to increase monetary stimulus.

Retail sales rose 0.9% in the month of August, which was slightly more than expected but not that impressive when taking into account the downward revision to the past month’s report. Also, the higher cost of gas was responsible for a large part of the gains because excluding gas station receipts, consumer spending rose only 0.3%. The consumer price report showed a similar influence by gas prices. CPI rose 0.6% last month but stripping out the costs of food and energy, prices rose a mere 0.1% and we know gas is to blame because excluding food, prices increased 0.7%.

Industrial production and the University of Michigan Consumer Confidence surveys will be released later this morning but don’t expect this report to pose much threat to the risk rally. While we expect the mood in the financial markets to continue to be supported by the flood of liquidity from central banks, the EUR/USD has enjoyed a very strong rally this week and is coming up on significant resistance. The 1.3140 level is the 38.2% Fibonacci retracement of the sell-off that started in May 2011 and lasted until July of this year. However if this level is broken, there is no major resistance until 1.35. Expect currencies to take their cue from equities today.

Kathy Lien
Managing Director

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