Data Drives Dollar, Stocks And Yields Lower

Weak Retail Sales Drive US Dollar, Stocks and Yields Lower

If you want an explanation for why the Federal Reserve refuses to put a time frame on tightening, look no further than Thursday’s retail sales report. Retail sales growth slowed to 0.3% in the month of May, down from 0.5% in April. Economists expected demand to rise to 0.6% and despite the 0.4% upward revision, the downside surprise last month indicates that consumer spending is weak especially considering the improvement in the labor market. Excluding autos and gas, sales stagnated after rising 0.3% the previous month. Lackluster demand is one of the main reasons why the Federal Reserve has been reluctant to talk about raising rates but aside from this report, jobless claims also increased and import price growth slowed. These disappointing numbers drove the greenback lower and put pressure on Treasury yields and U.S. stocks. Yet there was no major implication for Fed policy -- if anything these reports reinforce the central bank’s commitment to taper slowly and their intention to leave monetary policy unchanged for a long stretch of time before raising rates. For the forex market, this means a longer period of low volatility so while USD/JPY extended its slide Thursday, we continue to believe that the 100.75 to 103 range will remain intact for the time being. Producer prices are scheduled for release Friday along with the University of Michigan Consumer Sentiment Index and despite Thursday’s report, we expect confidence to rise on the back of the record breaking moves in stocks in early June and the improvement in the labor market.

EUR Rebounds, ECB Member Talks About Waiting on QE

After falling for four consecutive trading days, the euro rebounded against the U.S. dollar (EUR/USD). Stronger-than-expected industrial production and the overall weakness in the dollar helped the currency pair stabilize above the key 1.35 level. Industrial production rose 0.8% in the month of April compared to a forecast of 0.5%. On an annualized basis, IP growth accelerated from 0.2% to 1.4%. Unfortunately this rebound is not enough for the central bank to alter its dovish monetary policy stance. In their monthly report, the European Central Bank said they are strongly determined to maintain price stability and if inflation remains too low for too long, it may necessitate a policy response. According to ECB member Jazbec, “further rate cuts in general is still possible” but not necessary in the near term. He does not feel that the ECB’s actions will create bubbles and the measures are sufficient for the time being. Most importantly, he noted that while the ECB will act again if necessary, the central bank needs to wait and see before deciding on QE -- a view we believe many policymakers share. Since last week we have been saying that the losses in EUR/USD could be limited by a period of steady policy because the central bank will want to see how the economy responds to easing before taking additional action. Eurozone trade numbers are scheduled for release on Friday.

NZD Extends Higher, AUD Shakes Off Weak Labor Data

The New Zealand, Australian and Canadian dollars extended their gains against the greenback with NZD as the best-performing currency. The Reserve Bank’s hawkish monetary policy bias and decision to raise interest rates by 25bp sent NZD/USD up for the sixth consecutive trading day by 0.8%. The main takeaway from last night’s RBNZ statement is that the central bank intends to raise interest rates again in June. As a country with one of the highest interest rates in the world with a central bank planning to raise rates further, New Zealand should continue to attract foreign investment. However NZD/USD is closing in on 0.8730, a level that it has struggled to break in the past. There have been only 2 days this past year that the currency pair managed to break through this level and on both occasions it failed. Yet the main difference this time is that rally comes on the heels of a rate hike and a hawkish monetary policy bias that most market participants did not anticipate. This means there’s a greater chance of this level being broken and NZD/USD making a run for its 2-year high of 0.8780. The Australian dollar also performed well despite mixed labor market data. At first glance, the labor market report was terrible in that 4.8k jobs were lost compared to a forecast for 10k job growth. April numbers were also revised lower and while the unemployment rate remained unchanged at 5.8%, the participation rate dropped to 64.6% from 64.7%. When the data was first released, it triggered a nasty sell-off in AUD/USD. However once traders had a chance to look beneath the headline and saw that all of the jobs lost were part time with full time employment growing by 22.2k, they expressed their relief by bidding AUD higher. At the end of the data, the overall report was not nearly as weak as the headline numbers but it still raises some red flags for the labor market. The Canadian dollar on the other hand benefitted from the rise in oil prices. The price of crude broke $105, hitting its strongest level since September 2013. House prices in Canada increased at a steady pace with capacity utilization rising to 82.5% from 82.2% in the first quarter. The main focus over the next 24 hours will be on Chinese retail sales and industrial production. Acceleration in demand or manufacturing activity could send AUD and NZD to fresh highs.

How Far Can EUR/GBP Fall?

Despite the lack of U.K. economic data Thursday, the decline in U.S. yields drove the British pound higher against the U.S. dollar. While the strength of GBP/USD can be attributed to a decline in the greenback, sterling itself is in demand with EUR/GBP falling to a fresh 16-month low. The past 3 days have been marked by new lows in EUR/GBP and many traders are wondering how low EUR/GBP can go. On a technical basis, the currency pair has fallen through the 23.6% Fibonacci retracement of the 2011 to 2012 decline, which sits right at the 2010 swing low of 0.8070. With that level broken, there is no major support until 80 cents, which is psychologically significant and even this level could give way to more meaningful support at 0.7750. From a fundamental basis, EUR/GBP experienced such a deep sell-off due to the combination of euro weakness and sterling strength. Euro found support Thursday right above the key 1.35 level and given the low level of volatility in the market, more consolidation is likely. This suggests that it will be up to the GBP to drive the pair lower and so far there appears to be enough momentum to do so. BoE Governor Carney did not make any insightful comments Thursday but Chancellor Osborne did -- he announced that he would give the BoE power to cap mortgage lending ratios and he thinks they should not hesitate to use these new powers. The BoE has previously thrown the ball into the Chancellor’s court, calling for adjustments to the Home for Buy scheme and with Thursday’s announcement, the Chancellor has tossed the ball back in their direction -- a step that has driven sterling lower. No U.K. economic reports are scheduled for release Friday.

Yen: No Surprises Expected from BoJ

The Japanese Yen ended the day steady to higher against all of the major currencies except for the Australian and New Zealand dollars. The Bank of Japan was set for a monetary policy announcement Thursday evening and given the recent improvements in the economy, no change was expected. We expect Kuroda who speaks shortly thereafter to reiterate the central bank’s optimistic view that the sales tax increase in April will do limited damage to the economy. Last night’s machine orders report came in slightly better than expected with the annualized pace of growth in April rising to 17.6% from 16.1%. On a monthly basis, orders fell -9.1%, slightly less than the -10.8% forecast. The Ministry of Finance also released its weekly portfolio report and the most notable development was foreign demand for Japanese stocks. Foreigners bought Y343.5 billion worth of Japanese equities, the largest purchase in 13 weeks. Foreigners have been attracted by the recent rally in the Nikkei and the expectation of increased demand for domestic stocks by the Government’s Pension Investment Fund. Considering that Prime Minister Abe asked for early GPIF portfolio changes, we expect this demand from foreign investors to continue.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.