By all counts, this is an important and busy week for the U.S. dollar. With retail sales, inflation, manufacturing and consumer confidence reports scheduled for release, there’s no shortage of event risk on the calendar. However don’t expect this week’s economic reports to be a game changer for the U.S. dollar or U.S. monetary policy. Since the last Federal Reserve meeting on August 1st, we have seen very little movement in the greenback. On the day of the Fed meeting, the EUR/USD ended the North American trading session not far from where it started this new trading week at 1.2228. The biggest moves that we have seen over the past 2 weeks were in the Canadian and Australian dollars, which rose a mere 1 percent against their U.S. counterpart. The lack of volatility in the foreign exchange market has everything to do with the lack of clarity on the outlook of the European and U.S. economies and ECB/Federal Reserve monetary policies.
When the Federal Reserve last met, Bernanke made it clear that the central bank is not ready to make any rash decisions about monetary policy. Quantitative Easing is still on the table but only if the labor market continues to weaken and Europe’s sovereign debt crisis worsens. However neither has happened over the past 2 weeks and in fact, there have been signs of stabilization. The unemployment rate may have ticked up to 8.3% but the total number of jobs created easily exceeded 100k. More than 163k Americans found work last month, bucking a trend of below 100k job growth that worried everyone from policymakers to investors around the world. Spanish bond yields also remained below 7% for the second straight week but are beginning to creep back towards this pivotal level.
While this week’s U.S. data are what we consider Tier 1 economic reports because they have a direct impact on the Federal Reserve’s monetary policy, inflation and manufacturing is not the central bank’s primary problem. In all likelihood, these reports will show a small rise in inflationary pressures, caused primarily by the recent uptick in food prices. Manufacturing activity will remain steady with very little change in consumer confidence or the housing market. Retail sales is one of the most important U.S. releases and after 3 consecutive months of lower spending, sales are expected to rise slightly but once again, a large part of the increase is expected to be attributed to higher food prices. The price of corn has risen to a record high and in the U.S., corn is used as the basis of many foods as well as an input into gas. According to the U.S.’ ethanol policy, fuel companies are required to mix in 9% of corn-based ethanol into their gasoline and is used as feed for beef and poultry. Therefore a rise in consumer spending won’t necessarily be good news for the U.S. economy, particularly if it is in the form of higher prices and not a larger volume of goods sold. Regardless, retail sales are only expected to increase by 0.3%, which is nominal compared to the decline experienced in the second quarter. A rebound in spending will nonetheless reduce the pressure on the Federal Reserve to ease monetary policy.
Even if spending falls for the fourth consecutive month, it won’t be enough to force the Federal Reserve’s hand. At this point the central bank is focused on employment and Europe. For a third round of Quantitative Easing to happen, Europe would need to spiral out of control or the U.S. unemployment rate would need to rise back above 9%. The former is a more realistic risk than the latter which is exactly what central banks around the world are waiting to see and this wait in see mode should limit the volatility in most of the major currencies despite the abundance of U.S. data this week. Remember, August is a month when most of Europe is on vacation and the lack of big events on the European calendar could also mean lower volatility for the U.S. dollar.
At the end of the day, we believe that the busy data week won’t be a game changer for the greenback or Federal Reserve policy and the 1.2450 to 1.20 trading range in the EUR/USD should hold.
