2 Main Developments Driving Wednesday's Markets

There are two main developments in the foreign exchange market today. The first is a somewhat firmer than expected Australian inflation figures that have thrown cold water on creeping ideas that another rate cut could be seen before the end of the year. This has lifted the Australian dollar to $0.9450, where it stalled a couple of weeks ago.

The second is the less hawkish tone to the Bank of England minutes that encouraged some profit-taking on long sterling positions. This in turn has helped the EUR/USD stabilize against the dollar, as it is bought back against sterling.

Headline Q2 CPI from Australia was actually spot on with the consensus forecast at 0.5% for a 3.0% year-over-year increase. This compares to 2.9% in Q1. The problem lies with the trimmed mean that rose 0.8% for a 2.9% year-over-year pace. The consensus anticipated a 0.6% quarterly rise for a 2.7% year-over-year increase.

We suspect that many participants were looking for an excuse to buy the Aussie and the CPI data provided it. A move above $0.9460 would likely spur a retest of the $0.9500 area seen earlier this month. With the government suggesting a less anxious attitude about the currency's strength and with less rhetoric from the central bank itself, many participants sense less official headwind.

The minutes from the Bank of England meeting earlier this month did suggest a central bank that was on the verge of hiking rates. There were three issues. First, wages growth remains anemic. Second, the base effect of inflation warns of further downside risk in the coming months. Third, there is a sense that the economy may slow in H2. Already some of the data suggest the UK economy lost some momentum as Q2 wound down, but as the CBI Distributive Trades survey showed, the loss of momentum is not uniform. This measure of retail sales rose to 21 in July from 4 in June, which is the highest since February. The consensus was for 15-16.

Sterling slipped to marginal new low for the month on BOE minutes. Support is seen in the $1.7000-30 band. We look for the data over the next couple of days, which includes retail sales and the first look at Q2 GDP will help sterling stabilize, despite posting an outside day today. That said, a close below $1.7040 could signal another push lower first. If the $1.70 area breaks, we look for buyers to re-emerge ahead of $1.6950.

The euro’s price action is interesting, even though it has been confined to less than a quarter of a cent through the Asian session and European morning. Although a marginal new low has been recorded near $1.3455, there is no momentum to speak of. The bears, who had been champing at the bit, got the break of $1.3500 and the test on the weekly trendline going back to 2012. Yet, they have not piled on.

There are two considerations that may be restraining the bears. The first is that the speculative community has already amassed a large short euro position. This is evident in the futures market, which is often understood to be a proxy for short-term trend followers and momentum traders. The second is that some participants may be waiting for tomorrow’s flash PMI readings. Nevertheless, the tone remains fragile and the longer the euro holds below the $1.3480-$1.3500 area, the more the downside may beckon.

The main economic event of the North American session is the release of Canada’s May retail sales. The market expects a 0.6% headline increase after a 1.1% rise in April. Excluding autos, the rise may be closer to 0.3%. The data seems too dated to be particularly meaningful for participants. Watch the CAD1.07 area. The 20-day moving average comes in just below there and corresponds to a shelf carved out over the better part of the past two weeks. A break could signal a move back ot the CAD1.0620. area.