USD Fails To Follow Stocks And Yields

After a one-day pullback, U.S. stocks and Treasury yields resumed their rise but the dollar failed to follow. Instead of trading higher, the greenback lost value against most of the major currencies. The EUR/USD rose above 1.30 and USD/JPY slipped below 101 after a round of weaker than expected economic data. Equity and fixed income traders shrugged off the data but FX traders refused to budge. Long dollar positions are still being cut which suggests that currency traders are still worried about the volatility in the financial markets and the eagerness of the Fed to taper asset purchases. U.S. equity and fixed income traders have completely ignored the 5% drop in the Nikkei overnight. Japanese stocks are 13% off its highs and if it continues to decline, it may have ripple effects over to U.S. markets and keep the dollar in corrective mode. However if the Nikkei stabilizes and starts to recover, then the dollar has a chance of joining the recovery.

As we wrote in our morning note, Thursday's U.S. economic reports were not as terrible as the headline numbers suggest. First quarter GDP growth was revised down to 2.4% from 2.5% as lower government spending and weaker inventory rebuilding offset stronger personal consumption. U.S. jobless claims also rose to 354K from 344K and continuing claims reached 2.986 million, up from 2.923 million. While they missed expectations, these economic reports don't take the country off the road to recovery. While the economy grew less than expected in the first quarter, consumer consumption saw its biggest gain since the fourth quarter of 2010. Healthy U.S. demand should eventually lead to faster inventory replenishment and stronger underlying growth. Jobless claims increased but the absolute amount of claims filed is still relatively low and consistent with a continued labor market recovery and it did not take long for investors to realize that the Fed's plans for tapering asset purchases won't change because of the day's economic reports.

Personal income, personal spending, Chicago PMI and the final March University of Michigan consumer confidence numbers will be released Friday and while these reports are interesting, our focus will be on the global equity and bond markets as they will determine how currencies trade. Friday is also month end rebalancing and with the rise in the dollar and stocks this month, the dollar will need to be sold to rebalance portfolios.

JPY: Why Are The Japanese Selling Foreign Bonds?
A large part of the volatility in the equity and currency markets is happening during the Asian session. Last night, the Nikkei plunged 5%, causing USD/JPY to drop below 100.50. While the currency pair and most of the Japanese Yen crosses have bounced off their lows, investors are nervous about how the outlook for Japanese equities. USD/JPY is struggling to hold onto its gains and with 100 in sight, many traders are wondering if we've seen a top in the currency. We feel that in the long term, USD/JPY is still poised to make new highs above 103.75 but in the interim we have to acknowledge that the factors supporting the initial rally are no longer there. U.S. yields backed off its highs, the Nikkei is moving in the wrong direction (that is not making new highs) and the Japanese continue to sell foreign bonds. According to the latest report from the Ministry of Finance Japanese investors sold more than 1 trillion yen worth or foreign bonds, which was the second largest one week dump in the past year. While BoJ policies are aimed at weakening the yen and rising yields abroad should make foreign assets more attractive, the Japanese continue to sell their foreign holdings. There is one explanation - they are either repatriating their foreign investments, which may have increased in value and either parking them in savings accounts or recycling them back into the Nikkei. Meanwhile, pleanty of Japanese data is due as we have industrial production, the jobless rate, overall household spending, inflation and manufacturing PMI scheduled for release. The data should show continued improvement in Japan's economy but the momentum may have faded slightly.

EUR: Potential Upside Surprise In Retail
The euro continued to recover against the U.S. dollar, rising above 1.30 for the first time in two weeks. An uptick in euro zone economic confidence and weaker U.S. data helped the currency extend its recovery. The region's economic confidence index rose to 89.4 from 88.6 and while no milestones were reached, the improvement was enough to ease expectations for another move by the ECB. This is important but should pale in comparison to Friday's German retail sales report. Consumer spending is expected to rebound despite the pullback in employment. According to the Retail PMI report, German retail sales saw its strongest increase since June 2012, which bodes well for the official release. Once again, the Swiss Franc is on the move with USD/CHF seeing the largest movement amongst the major currencies. Aside from dollar weakness, USD/CHF was also hit by the stronger than expected increase in Swiss GDP growth. Switzerland's economy expanded by 0.6% in the first quarter or four times faster than expected thanks to robust consumer spending in the first three months of the year.

NZD: RBNZ Comments Leave Lasting Impression On Currency It was a topsy-turvy day for commodity currencies. The New Zealand dollar resumed its slide whereas the AUD and CAD extended their recoveries. Economic data from New Zealand was good with building permits rising 18.5% but comments from RBNZ Governor Wheeler left a lasting impression on the forex market. Last night, Wheeler warned that the central bank could step up intervention efforts to curb the rise in the currency. What was interesting is that these comments come on the heels of an 8% slide in NZD/USD but what the RBNZ is worried about is not NZD strength against the greenback but against the AUD. Australia is New Zealand's most important trading partner and right now the NZD is at its strongest level against the AUD in four years. The AUD experienced quite a bit of intraday volatility as the currency pair rallied after a 9.1% surge in building approvals, then sold off on the 4.7% decline in capital expenditures only to recover again to end the day higher after weaker U.S. data. The currency pair is trying to carve out a bottom above 95 cents and if it manages to close above 97 cents, there is scope for a stronger recovery towards parity. Meanwhile Canada also reported mixed economic data - the country's current account deficit narrowed slightly but industrial product and raw material prices plunged sharply. Lower inflation and a healthier balance sheet should keep the Bank of Canada firmly on hold.

GBP: Lifted By Weaker Dollar And Stronger House Prices
The British Pound extended its gains against the U.S. dollar following an increase in house prices and a rise in Business Confidence according to a survey conducted by Lloyds. This is an exceptionally quiet week for sterling with the currency primarily taking its cue from the U.S. dollar. Nationwide house prices rose 0.4% in the month of May, which was slightly weaker than anticipated but still an improvement from the previous month. On an annualized basis, house prices grew 1.1% yoy, up from 0.9% growth. According to the mortgage lending, the U.K. housing market is "gradually" gaining momentum. Their Chief Economist Robert Gardner said, "there has been an improvement in the availability and a reduction in the cost of credit, partly as a result of policy measures, such as the Funding of Lending Scheme, a policy implemented by the BOE to increase lending to businesses by lowering interest rates and increase access to credit. More housing market reports are expected Friday with the anticipated release of net consumer credit, net lending and mortgage approvals. Our eye will be on consumer confidence, which is expected to have improved slightly in May.

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