Dollar: Potential for Consolidation

June - 10 - 2010 Author: Christine Allen Respond

The resilience in the financial markets on Friday was impressive considering that retail sales nosedived in the month of May. Stronger consumer confidence helped to soften the blow, but spending is a big contributor to the U.S. economy and the disappointment should have weighed heavily on risk. Yet, the Dow ended the day in positive territory while the dollar traded higher against the Japanese Yen. Since our morning report, we have learned that the expiration of the cash for appliances program, which did not receive nearly as much attention as the cash for clunkers program played a big role in the 9.3 percent drop in sales of building materials stores. This implies that the retail sales report was not nearly as ugly as the headline numbers suggest. With the ECB meeting behind us and the Fed meeting scheduled for the 23 rd , there is potential for consolidative price action next week.

Potential for Consolidation

The ECB and the European Union had their opportunity to act but they have chosen not to introduce any new measures. Given the rebound in the euro this past week, the pressure for more attempts to restore consumer confidence has diminished. With the Fed not expected to meet for another week, there are no potentially game changing event risk on the U.S. and European calendars. There are a number of economic reports scheduled for release, but they are not nearly as market moving as the ones that have already been released. Of course, there is always the chance of European or U.S. policymakers making unanticipated announcements but based upon the schedule of event risks next week, the most important report will probably be the Treasury International Capital flow data. The TIC data is interesting because it will shed light on what China has been doing. The euro has fallen significantly so China should be worried about their exposure to euros, yet the Americans have been pressuring for revaluation so China may have protested by buying fewer U.S. dollars. The Empire State and Philadelphia Fed surveys are also scheduled for release along with inflation reports, housing numbers and leading indicators. The strong dollar may have reduced inflationary pressures while at the same time crimping expansion in the manufacturing sector. Another round of weak numbers will hurt the credibility of Fed Chairman Bernanke who was slightly more upbeat when he testified before the House Budget committee earlier this week.

Was Retail Sales Distorted by Cash for Appliances?

When the market saw that U.S. retail sales fell 1.2 percent last month, traders quickly sold the U.S. dollar and bailed out of stocks. Most economists including ourselves were looking for stronger retail sales, but to everyone’s surprise, American consumers cut spending despite the continual improvement in the labor market. Finding jobs was apparently not enough to get Americans to spend as today’s number suggests that the quality of jobs is far more important than the quantity. However we have learned that the fading cash for appliances program was the primary cause for the decline. Excluding autos, building materials and gas station sales, consumer spending actually rose 0.1 percent. Although hardly something to write home about, positive spending is better than negative. There was also a pickup in online spending and furniture sales. Since the labor market is improving, we still believe that American consumers are adding to their rainy day funds which are important if they know that their jobs are temporary. Yet, the increase in consumer confidence is encouraging particularly since the University of Michigan survey rose to the highest level in more than 2 years. Some people may argue that the UMich survey only polls 500 households but the fact that this small but statistically legitimate sample of people grew more optimistic shows that even the slump in stock prices and slower private sector payroll growth has not taken a big toll on sentiment.

EUR: OPTIMISM ON GERMAN GROWTH

A minor pullback in the euro ended what was a relatively subdued three day climb against the dollar. On a good note, the Bundesbank decided to raise its forecasts for German growth, citing the fact that “the economic recovery noticeably gained pace.” The bank predicts that growth will come in at 1.9% for this year, an estimate which is slightly more optimistic that the 1.6% expansion predicted previously. One of the “main driving forces” for the economy was the surprising health in the export sector, thanks in part to an unabashed decline in the euro. The bank also foresees that the recent damage in confidence will have a limited impact on the recovery going forward. Separately, Bini Smaghi, an ECB executive board member, responded to recent speculation of the chances of a country exiting the Eurozone. Smaghi said that such concerns were unfounded considering the fact that the costs of a country abandoning the euro would be “far more expensive” than simply instituting necessary fiscal consolidation measures. Smaghi claims that any exodus from the region would have “highly detrimental effects on everyone.” Next week brings the ZEW Economic Sentiment Survey and Eurozone Employment on Tuesday, followed by EZ Consumer Prices on Wednesday. However, with the ECB meeting out of the way and nothing truly groundbreaking expected next week, it is likely that the euro falls into a trend of consolidation. On a separate note, according to the latest Commitment of Traders report, as of last Tuesday, forex traders increased their short euro and long dollar positions to levels just shy of record highs. Although the Swiss National Bank has a monetary policy meeting next week, the strength of the Swiss Franc will discourage the SNB from raising interest rates.

GBP: BIG WEEK AHEAD

The British pound fell steeply against the U.S. dollar on the heels of weaker manufacturing data. Industrial production fell 0.4 percent in April which was a big surprise as the market was looking for continued growth. Although the primary drag was from a decline in car production, the fact that the sell-off in the pound did not boost manufacturing activity is extremely worrisome. The producer price report on the other hand was mixed. Output prices grew less than expected in May while input prices declined by a smaller amount. The lack of clarity on the health of the U.K. economy should be addressed by next week’s economic reports. For the past few months, the focus has been on the countries that use the euro but the other European nation – the U.K., will get a bit more attention next week. With a new government in place headed by David Cameron, the youngest British Prime Minister in almost 200 years, change is on the horizon. For currency traders seeking some action in the British pound, change is more than welcomed as the currency pair has been contained within a 300 pip trading range for the past few weeks. A mild breakout in late May only took the GBP/USD from one range into another. Thankfully this week’s economic reports are significant enough to trigger a breakout that will hopefully turn into new trend for the currency pair. The week starts off with U.K. consumer prices on Tuesday, followed by the employment report on Wednesday and retail sales on Thursday. With the new government having recently been installed, the Bank of England did not want to rock the boat this week by changing monetary policy. However even if the current government was still in power, previous data showed that not much had changed between the May and June meetings. This makes this week’s economic reports particularly critical because they provide a fresh look at the performance of the U.K. economy. The BoE has so far ignored the rise in CPI and chocked it up to temporary factors, but if inflationary pressures escalated last month, they may not be able to downplay it for much longer. Hotter inflation numbers should drive the GBP higher. Meanwhile the amount of Britons filing for jobless claims is expected to fall for the fourth consecutive month, driving the unemployment rate down in the process and then consumer spending will be the last piece of the puzzle.

CAD: LOONIE BREAKS FOUR DAY RALLY

Commodity currencies are relatively mixed on the day, with the loonie ending a four-day rally, the aussie pausing a tremendous three-day advance, and the kiwi gaining for the fourth straight day. Economic data was relatively light, but we did see Capacity Utilization from Canada which grew at the fastest pace on record. The rise in utilization underscores the healthy growth in the industrial sector as companies have to put more resources to work to deal with the rise in demand. Canadian Finance Minister Flaherty has been quite vocal about the situation in Europe, saying that fiscal consolidation for the nations should remain top priority, while ensuring growth for the nations remains secondary. Clearly, the Canadians, although affirming that the European affect has been minimal, are worried that the contagion still has room to spread. Canada has Labor Productivity on tap for Wednesday and Leading Indicators for Friday. The New Zealand dollar continued to rally off Wednesday’s rate decision and will face Retail Sales Sunday night and ANZ Consumer Confidence on Thursday. The RBA is preparing their minutes due for release on Tuesday, to be followed by the Westpac Leading Index on Wednesday.

JPY: KAN PLANS DRASTIC REFORM

USD/JPY remains range-bound as traders reevaluate their demand for a safe haven. Prime Minister Kan spoke adamantly today about the need for Japan to start a program to pare back its debts. Kan says that “our country’s outstanding debt is huge, making it difficult to cut in a short space of time.” Nevertheless, Kan urges that “drastic reform” be started immediately. The new administration will more completely outline its plans in its fiscal strategy to be finalized this month. Nevertheless, the move toward fiscal austerity is complicated by the fact that the DPJ still plans to meet campaign promises of additional welfare spending. Kan also spoke of the BoJ in his speech today, saying that “the government will take strong and comprehensive steps” with the bank to ensure the deflationary threat is addressed. His call for more influence over the BoJ comes after Finance Minister Noda affirmed his preference that the bank be kept independent. The Bank of Japan’s rate meeting should be the highlight of next week’s calendar. It is expected that the bank will propose a program to ease credit conditions for private companies. However, many worry that such a proposal will carry with it little impact on markets. Also prepare for the BSI Large Manufacturing Index on Sunday and the Tertiary Industry Index on Tuesday.

CHF/JPY: Currency in Play for Next 24 Hours

The CHF/JPY will be the currency pair in play for Monday. In Switzerland, we expect the May Producer Price Index figure at 3:15 ET or 7:15 GMT. In Japan, we have the BSI Manufacturing Index figure on Sunday at 19:50 ET or 23:50 GMT and the Bank of Japan’s Target Rate Decision and Monetary Policy Statement on Monday.

CHF/JPY is currently trading in the Range-Trading zone, which we determined using Bollinger Bands. The nearest level of resistance, at 80.05, is the pair’s the Upper One-Standard Deviation Bollinger Band, which corresponds to trendline resistance. Near-term support for the pair lies at 79.10, its 10-Day Simple Moving Average which coincides with trendline support. For the past 2 weeks, the CHF/JPY has been consolidating between 78.00 and 80.00. The pair appears to be battling a much larger downtrend and if it breaks these levels, we could see major movement in either direction.

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