Which Will Impact USD More: Retail Sales Or Fed Minutes?

It has been quiet a week so far for U.S. data but that changes Wednesday with the October retail sales report and FOMC minutes scheduled for release. These are some of the most important pieces of U.S. data and certainly the most important event risk this week. With the market still divided on the timing for tapering, the level of consumer spending last month and the bias of the central bank after the U.S. government shutdown will play a key role in how the dollar trades. Since the last central bank meeting we have seen improvement and deterioration in the U.S. economy along with more and less dovish comments from FOMC officials. As such, investors are no more certain of how quickly the Federal Reserve will reduce asset purchases than they were before this month's strong non-farm payrolls report. Between the retail sales report and the FOMC minutes, we are much more interested in retail sales because the minutes should reveal that the central hasn't made up its mind on monetary policy.

When the FOMC statement was released, the dollar soared because the central bank sounded open to the idea of tapering asset purchases in December. The Fed was not overly concerned about the sluggish pace of job growth in September and even said labor market conditions have improved. Since then, this optimism has been verified by the latest payrolls reports. The central bank is also no longer worried about tighter financial conditions or higher mortgage rates that could have slowed the recovery. They wanted to continue to monitor incoming data to determine when it would be appropriate to adjust the level of asset purchases, a message that the FOMC minutes will most likely carry.

As for retail sales, with retailers announcing their Black Friday sales early, investors are starting to look ahead to this year's holiday shopping season. The U.S. retail sales report is scheduled for release on Wednesday and if spending contracts for the second month in a row, the U.S. will need consumers to spend voraciously this season for the Federal Reserve to seriously consider tapering this year. Based upon Tuesday's reports from the International Council of Shopping Centers and Johnson Redbook surveys, retailers will need to fight hard for each sale. Not only do we have a late Black Friday but consumers have become extremely deal conscious. According to Bloomberg, this could be the weakest holiday shopping season since 2009. Stores have too much inventory, retailers are discounting heavily and introducing a number of incentives to boost sales. Wal-Mart for example is introducing its lowest rate flat screen TV (one of its biggest Black Friday promotions) at 33% less than last year. Malls are luring in consumers with free parking and coffee while online retailers have introduced same day delivery for as little as $3.99 per shipment. A weak holiday shopping season could hurt the market's appetite for dollars and the first test will be Wednesday's retail sales report.

Federal Reserve Chairman Ben Bernanke was slated to discuss communication and monetary policy Tuesday evening before the Economics Club in Washington. Considering that he is speaking at a dinner, a Q&A session is unlikely. As such we are not looking for any surprising comments from the head of the central bank on monetary policy.

EUR: Supported By Stronger Investor Confidence
The rally in euro gained momentum Tuesday on the back of better than expected euro data. On Monday we asked whether the euro would prove its strength this week and so far it is off to a good start. German investor confidence rose to its highest level since October 2009. While investors grew less optimistic about current conditions, the recent interest rate cut has made the outlook brighter. Of the 3 reports on the calendar this week, the ZEW is generally the least market moving for the euro compared to PMIs and IFO because the former is a measure of confidence and the latter are measures of activity. Nonetheless, the PMIs and German IFO should benefit from the same rate cut as the ZEW. As we are looking for improvements in all 3 reports, EUR/USD should be able to hold onto its gains as long as the FOMC minutes aren't overly hawkish and U.S. retail sales growth remains modest. Meanwhile ECB governing council member Praet also shed light on the central bank's recent decision to lower rates. He said "although we had been surprised by a drop in inflation in October to 0.7%, that was not the reason we lowered the rate on the main refinancing operations on November 7. The reason was that we were expecting inflation to remain weak ...for an extended period of time" and "we believe our decision has rebalanced the risks to price stability, which had become tilted to the downside. We think deflation was not in sight before, and has become even more unlikely after our decision. Our decision has increased the buffer against unwelcome price surprises." These comments suggest that barring a significant deterioration in the euro-zone economy, the ECB won't be looking to cut interest rates again -- another plus for the euro.

GBP: What To Expect From The BoE Minutes
The most important release for the U.K. this week will be Wednesday's Bank of England minutes. That does not automatically mean that sterling will see a big move Wednesday because it would be contingent upon an unexpected announcement from the central bank. We know from the Bank of England's Quarterly Inflation report that monetary policy committee members have grown slightly less dovish and expect their unemployment rate target to be achieved one year earlier than previously forecasted. Data has been mixed with manufacturing activity weakening but service sector accelerating. The BoE left monetary policy unchanged at its last meeting and back in October they widened access to liquidity insurance and lowered its costs with the hope of providing ongoing support to the economy. Their decision to maintain steady policy in October was unanimous and we the expect same to be true for November. However if there is even one member that favors an earlier withdrawal or believes that more QE is needed, sterling could react sharply as this would represent a shift in monetary policy bias for the central bank. Outside of the voting record, we expect a generally cautiously optimistic tone that should pose no major threat to the current rally in sterling.

AUD: RBA Still Open To More Easing
The Australian, New Zealand and Canadian dollars extended their gains against the greenback thanks to another important announcement from China. The Chinese government plans to gradually expand the Yuan's trading band and eventually transition to a managed floating exchange rate. The detailed breakdown of China's basket peg is unknown, but the U.S. dollar is widely believed to account for the majority share and a wider trading band means that China needs to buy fewer U.S. dollars, which would be positive for the AUD, NZD and CAD. This announcement helped the A$ recover from losses that occurred after the RBA minutes. The minutes verified the central bank's concerns about its "uncomfortably high" currency and confirmed that they are open to the possibility of additional easing. The RBA said it would not "close off the possibility of reducing it further," as a "lower level of the exchange rate would likely be needed to achieve balanced growth in the economy." Nonetheless, there's reason to believe that Australia's economy is improving with the Conference Board's leading indicators index ticking up in the month of September. A similar survey was scheduled to be released from Westpac Tuesday evening. No economic reports were released from Canada but producer prices surged in New Zealand during the third quarter. Input prices rose 2.2% from 0.6% in Q2 while output prices rose 2.4%, up from 1%. Hotter inflationary pressure will keep the RBNZ on track to raise interest rates next year.

Yen Drops To New Lows Against European Currencies
The Japanese Yen dropped to a fresh 3-year low against the euro and 23 year low against the Swiss Franc Tuesday. While we have seen broad based yen weakness, investors have been focused on USD/JPY, watching closely to see if the currency pair is able to sustain its break above 100. Throughout this period however, the breakout moves in yen crosses gained momentum. CHF/JPY rose to its strongest level since 1990 and is at the cusp of breaking through 110, a technically significant level. In the past 8 trading days alone, we have seen between 1.5% to 2.9% rise in all of the yen crosses. Since the beginning of the year, these numbers range between 5% for AUD/JPY to 18% for EUR/JPY. As long as stocks hold steady and ideally trends higher, we could see further gains in Yen crosses. Abenomics is aimed at weakening the Yen and with the central bank open to the idea of additional stimulus if the consumption tax takes a big bite out of the economy, monetary policy in Japan supports a lower currency. Last night's Japanese economic reports missed expectations, signaling that Japan has a long way to recovery. Nationwide department store sales dropped 0.6% in October while the leading and coincident index were revised lower for the month of September. Japan's trade balance was due to be released Tuesday evening as the deficit was expected to narrow on weak Yen-boosted exports.

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