Dollar Under Pressure On Data, Budget Showdown

The U.S. dollar traded lower against all of the major currencies, Wednesday, except for the AUD and NZD. With only second tier economic reports released this week, we have not seen any big moves in the U.S. dollar. The almost daily decline in U.S. yields tell us that investors still believe the chance of no tapering this year outweighs the chance of tapering but some Federal Reserve officials have suggested otherwise which means the option of a reduction in asset purchases this year remains on the table. The decision will hinge on incoming data and based on Wednesday's release, the outlook for the U.S. economy hasn't gotten any clearer. Durable goods orders rose 0.1% in the month of August, which was stronger than expected but core durable goods orders fell 0.1%, much weaker than the market's forecast for 1% growth. New home sales beat expectations rising 7.9% in the month of August but the median price dropped to its lowest level since January and the number of months that new homes remained on the market hit its highest level this year. Each piece of good news that we have seen from the U.S. masked underlying weakness and until this changes, there will be reluctance inside the Fed to change the level of asset purchases.

Meanwhile the fiscal showdown in Washington continues to be the leading story in the financial market. Treasury Secretary Jack Lew said the U.S. will hit the debt ceiling no later than October 17 and when it does, the government could have less cash on hand than initially estimated. According to the letter written by Lew addressed to House Speaker John Boehner "We estimate that, at that point, Treasury would have only $30 billion to meet our country's commitments, far short of the net expenditures on certain days, which can be as high as $60 billion." The debate will continue through the weekend as the House takes its time to draft an alternative bill and propose legislation that could increase the government's borrowing limit. If a deal is reached, it will most likely be at the eleventh hour and the consequence of no deal is high -- it could lead to the first U.S. default ever.

Weekly jobless claims, pending home sales and final Q2 GDP numbers are scheduled for release Thursday. GDP growth is expected to be revised higher but a further decline is expected for pending home sales. After two weeks of computer related distortion in jobless claims, investors will be watching this report closely for an update on the labor market.

EUR Lifted Sharp Rise In German Consumer Confidence
The euro rebounded against the U.S. dollar, Wednesday, on the back of stronger consumer confidence reports. Germany's GfK consumer confidence index rose to its highest level in six years. This optimism points to the possibility of stronger consumer spending and in turn stronger growth for the euro-zone's largest economy. Despite mixed economic data and weakness in the manufacturing sector, German businesses, consumers and investors have grown more optimistic about the economic outlook in the past month. Yesterday, the expectations component of the IFO survey increased and earlier this month, the ZEW survey of investor confidence also beat expectations. This improvement in sentiment was driven in part by the upcoming elections and stronger growth in China. Italian consumer confidence also improved with index breaking the 100.00 barrier for the first time in several years. Unfortunately for the ECB to drop its dovish bias and talk of more LTRO, stronger confidence needs to translate into consistent and broad based improvements in data. The euro zone still faces quite a bit of uncertainty and as our colleague Boris Schlossberg pointed out, "ECB officials are clearly not pleased with the sudden rise in the exchange rate and have been trying to talk down the currency. More importantly, the German election results have yet to produce a ruling coalition government with SPD apparently driving a hard bargain with Angela Merkel. Ms. Merkel may turn to the Greens for a possible partnership, but such an arrangement would be inherently less stable than the CDU-SPD union. Lastly, if no deal can be negotiated, Germany may face the prospect of another election, which would no doubt put downward pressure on the euro as uncertainty reigns."

GBP Rebounds On Signs of Stronger Spending
The British pound rebounded against the U.S. dollar on signs of healthier consumer spending. According to a survey conducted by the Confederation of British Industry, retail sales rose at its strongest pace in 15 months. The CBI index jumped from 27 to 34 on the back of increased spending at grocery and furniture stores. Economists had actually been looking for spending to slow so this reading should notch up expectations for the more closely followed retail sales report. While the Chairman of the CBI said "the retail sector is not out of the woods yet with consumer confidence still fragile," Wednesday's report is yet another reason for investors to prefer sterling over other major currencies. Consistent improvements in U.K. data along with optimistic comments from BoE officials have and should continue to keep the GBP/USD above 1.60 in the near term. We also expect EUR/GBP to retest its nine-month lows at 0.8350. Revisions to Q2 GDP and current account numbers are scheduled for release from the U.K. on Thursday. Unlike the U.S., changes to previous estimates to the U.K. GDP report are rare and as such, we expect sterling to hold onto its gains.

NZD Extends Losses After Large Deterioration Trade Weaker-than-expected economic data drove the New Zealand and Australian dollars lower against the greenback. The sell off in NZD gained momentum after last night's wider than expected trade deficit. As we wrote in Tuesday's note, the drop in the manufacturing PMI index signaled the possibility of deterioration in trade activity but we did not expect New Zealand to report its largest trade deficit since September 2008. This deterioration sent NZD tumbling and while the RBNZ could be annoyed by the recent release, it may not be enough to prompt the central bank to drop their bias to raise rates next year because the widening of the deficit was largely caused by one off imports of a drilling platform and railway wagons from China. In Australia, skilled vacancies grew only 0.3% in the month of August compared to 0.5% the previous month. The last labor market report from Australia was very weak and based on this report there has been very little improvement since then. With no data on the calendar, the Canadian dollar continued to consolidate. We don't expect any big moves in the pair in the near future.

JPY: Gradual Improvements In Data Confirm Recovery Underway
The Japanese Yen continued to trickle higher against the U.S. dollar but traded steady against most of the other major currencies. Last night's Japanese economic reports were all better than expected, confirming that Japan's recovery is underway. The small business confidence index ticked up from 49.7 to 49.8, the corporate service price index was revised up to 0.6% and machine tool orders was revised from -1.8% to -1.7%. While none of these gains were material they are all a step in the right direction. The Japanese government still needs to consider increasing stimulus especially if they plan to raise the consumption tax and October 1 is when the big announcement is expected. The increase in the corporate service price index indicates that Japan is slowly beating deflation. Losses in the Nikkei and U.S. 10-year yields is keeping USD/JPY under pressure. With no major U.S. or Japanese data scheduled for release over the next 24 hours, we do not expect any big moves in USD/JPY. In the near term, the 100 level should limit the upside for the pair and 97 the downside,

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