US Data Hardens Case for QE3

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A round of weak U.S. economic data triggered a wave of risk aversion in the currency market. The EUR/USD, GBP/USD, and AUD/USD fell steeply after the 10am ET releases. USD/JPY also sold off but not nearly as much as the other high beta currencies. Evidence of weaker growth in the U.S., China and Europe raise fresh concerns about the outlook for the global economy. Even if the Eurozone manages to cobble together a larger safety net for the region, demand is still a serious problem. In the U.S., manufacturing activity in the Philadelphia region contracted by the largest amount since August 2011. Economists had anticipated a small improvement but instead, the pullback deepened. Existing home sales also dropped 1.5 percent in May after rising 3.4 percent the previous month. Although the average price of a home sold increased, the amount sold was the lowest this year. Not all news was bad however – leading indicators rose 0.3 percent while jobless claims dropped slightly to 387k from an upwardly revised 389k. In our note yesterday, we said today’s reports would not make the Federal Reserve any less dovish but the weak numbers have hardened the case for QE3.

Earlier this morning, Canadian retail sales were surprisingly weak, driving the loonie lower against the greenback. While losses in the CAD have been small, the 0.5% decline in spending was unexpected given the strength of the labor market and the improvement in demand on the wholesale level. Spending pretty much fell across the board in April with clothing and shoe stores experiencing the sharpest decline. Demand for discretionary items such as sports goods, hobby, books and music also fell while purchases of alcohol and healthcare items increased. Excluding autos, sales dropped 0.3 percent, which was slightly less than the headline number but motor vehicle and parts sales also contracted. For the Bank of Canada, the pullback in spending raises questions about their plans to tighten monetary policy. The BoC has been the only central bank talking about raising interest rates but with consumers cutting back on spending and the possibility of Europe’s debt crisis spreading, the BoC will need to rethink their plan to raise interest rates.

Meanwhile across the Atlantic, European currencies are trading lower across the board despite the continuous decline in 10 year Spanish bond yields. Weaker German PMI numbers raised concerns about the ability of the Eurozone’s largest nation to provide cover for the rest of the region. With manufacturing activity contracting and service sector activity grinding to a halt, Europe needs not only an economic union to fortify the region but also stimulus to promote growth. While Eurozone Finance Ministers are meeting behind closed doors to find a way to form a more integrated fiscal and monetary union, investors are once again growing concerned about their ability to end the crisis. With Moody’s expected to downgrade U.K. banks today, S&P expressing concern about the ability of Spain’s bank bailout to cure the country’s short term funding needs and the independent Spanish bank audit results due in a few hours, investors realize there is no easy way out of the crisis. We agree and continue to believe that any rally in the EUR/USD should be looked at as an opportunity to sell at higher levels.

Kathy Lien
Managing Director

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