US dollar soft ahead of retail sales

The USD has lost a fair bit of ground in February failing to benefit from a renewed rise in US Treasury yields. A more positive risk environment recently has undermined some of the demand for USDs while some negative data surprises such as the ISM manufacturing survey and non farm payrolls have also weighed on demand for the USD.

The release of January retail sales data today will give another opportunity to gauge the path of consumption at the turn of the year but unfortunately for the USD a relatively flat outcome for sales will provide little rationale to buy the currency. The consensus expectation is for headline retail sales to post a 0% monthly reading, while sales ex autis is likely to rise by a measly 0.1%.

In the near term this implies little potential for a USD rebound but over but over coming weeks I expect the USD to rally in line with higher US yields. USD index (DXY) is likely to flatline around the 80 level in the coming sessions before rallying over coming weeks.

Fed shift hits the dollar

The economic trajectory into Q2 continues to worsen, a factor which likely played into the statement from the Federal Reserve that it is “prepared to increase or reduce the pace of its purchases” of assets, a marked shift from the previous stance of assessing the timing of a reduction of Fed asset buying noted at the March FOMC meeting.

Reinforcing the view was the weaker than expected increase in private sector payrolls in the April ADP jobs report (119k versus 150k consensus), implying downside risks to the consensus for tomorrow’s April non-farm payrolls data. Indeed, we now look for a 120k increase in payrolls compared to 150k previously expected.

March US construction spending was also weaker than forecast while the ISM manufacturing index dropped, albeit remaining in expansion territory (above 50). The data led to a further drop in the USD, commodity prices, equities and lower US Treasury yields.

Little change in market direction is expected today, with caution ahead of tomorrow’s US jobs report. Ahead of this, a likely 25bps cut in policy rates by the European Central Bank will capture attention. Although by no means a done deal, the majority of the market has shifted towards such an expectation in the wake of weaker data.

The real surprise from the ECB could come from any further hint or announcement of non conventional measures. In turn any such hint could dent the EUR limiting its ability to capitalise on a weaker USD tone. In any case sellers are likely to emerge on any rally in EUR/USD to resistance around 1.3220.

Final readings of purchasing managers’ indices in Europe, US March trade data and Q1 non farm productivity will account for the remaining releases today although none of these are likely to be market movers, leaving the USD under pressure ahead of tomorrow’s jobs report.

Calm ahead of US payrolls and ECB meeting

It’s non-farm payrolls week in the US, with currencies treading water until Friday when the report is released. Ahead of the data there are several other releases on tap which will give clues to the outcome of the April jobs report, including the ISM manufacturing survey and ADP jobs report. The USD has taken a softer tone as risk appetite improved and US bond yields dropped further.

Given the Fed kept open the door to more easing it will act as a restraint on the USD unless markets become convinced that there will no further Fed balance sheet expansion over coming months. In the meantime unless risk aversion spikes again the USD is set to find it difficult to sustain any gains.

It’s always the same story with the EUR, a tale of ongoing resistance to bad news. Weaker Eurozone confidence surveys as well as a downgrade to Spain’s credit ratings did little to weaken the EUR. The key event is the European Central Bank (ECB) meeting on Thursday but despite growing growth worries, a policy rate cut is unlikely as the ECB remains in wait-and-see mode.

Data releases will not be too damaging for the EUR, with monetary and credit aggregate set to rise and German retail sales set to rebound in March. The EUR looks poised to edge higher against this background in the short term, but will be constrained by uncertainty ahead of the US jobs report. Technical resistance to the upside will be found around the 1.3265 area.

The JPY barely flinched when the Bank of Japan announced an expansion of its asset purchase fund by JPY 10 trillion in its aim to reach a 1% inflation goal. Unfortunately for the BoJ the ongoing narrowing in the US Treasury yield premium over Japan JGB yields overwhelmed the negative impact of its action on the JPY.

Overall, my quantitative models continue to show USD/JPY lower over the short term, with a move below 80.00 on the cards. If as I expect, risk aversion also creeps higher, it will imply more short term upside JPY pressure. Trading will be relatively quiet, with no major data on the calendar due to Golden Week holidays in Japan.

US dollar on a firm footing

The stronger than expected US February jobs report (227k versus 210k consensus) and the Greek debt swap should by rights have set a positive tone to markets this week. Unfortunately this is not the case and cautious is set to prevail, with sentiment dampened in part by China’s wider than expected $31.5 billion trade deficit posted in February.

Officials in Europe are set to finalise Greece’s second bailout today but sentiment is unlikely to be boosted as various concerns creep into the market. Growing scepticism about the fact that the Greek bailout fails to correct the country’s underlying problems, worries about whether Portugal will follow in Greece’s wake, fiscal slippage in Spain and the Irish referendum, all point to ongoing tensions in the weeks ahead.

The Federal Reserve FOMC meeting takes centre stage over coming days while data releases including retail sales, industrial production and manufacturing surveys will also prove important for USD direction. The USD reacted positively to the lack of quantitative easing (QE) hints by Fed Chairman Bernanke recently and the stronger than expected February jobs report has reinforced this view.

The USD starts the week on a firm footing but could face renewed pressure if the FOMC statement proves to be more ambiguous on the issue of QE. US data releases will reinforce signs of economic recovery and if they play into a ‘risk on’ tone the USD could suffer. We believe this is unlikely however, with risk assets set to correct lower over coming weeks, playing positively for the USD.

Having rallied following the growing optimism over the Greek PSI debt swap the EUR will find limited support in the days ahead. News of 85.8% participation will have come as relief but the use of collection action clauses (CAC) is not so positive. At least finalisation of the second Greek bailout will now move ahead, with officials set to rubber stamp the deal today.

Data releases such as the March German ZEW survey tomorrow will highlight the sharp turnaround in investor confidence following the ECB’s LTRO and progress on Greece. This would usually bode well for the EUR. However, it is already proving to be a case of buy on rumour, sell on fact outcome for the currency. Potential for a drop below support around EUR/USD 1.3055 is growing as the USD builds momentum.

Following February’s surprise decision by the Bank of Japan to expand its asset purchases and set an inflation goal, the outcome of the policy meeting on Tuesday will deliver few punches. Having weakened in the wake of the last BoJ meeting, partly as a result of higher US bond yields relative to Japan, the JPY threatens to pull back against the USD to support around 80.50.

Improved risk appetite has helped to maintain some pressure on the JPY but this impact ought to prove limited unless yield differentials continue to widen. While the BoJ’s actions will likely keep Japanese government yields supressed, JPY direction will continue to be dictated by the gyrations in US bond yields.

Euphoria fades, risk currencies weaker

The euphoria emanating from last week’s eurozone agreement will likely fade into this week as renewed doubts creep in. Details of how the EFSF bailout fund will be leveraged or how the special purpose vehicle will be utilised have yet to emerge while the firewall to protect countries such as Italy and Spain may still be insufficient given that the use of the European Central Bank (ECB) to provide unlimited support has been ruled out.

With more questions than answers markets will be hungry for further details over coming weeks and until then it is difficult to see risk appetite stretching too far. One indication of such concern was the fact that Italy’s borrowing costs climbed to euro-era highs the day after the European Union (EU) plan was agreed. The G20 meeting on 3-4 November will be eyed for further developments as well as further reaction to the EU agreement.

There are plenty of events to digest this week that could add to any market nervousness. In terms of central banks we do not expect to see any change in policy stance from the ECB, Federal Reserve or Reserve Bank of Australia (RBA) this week but the decisions may be close calls. The ECB under the helm of new President Draghi will be under pressure to ease policy as growth momentum has clearly weakened but the Bank will likely hold off for the December meeting when new growth and inflation forecasts will be released.

The RBA may also take some solace from a better global economic and market climate but the market disagrees having priced in a cut this week. The Fed will look to see how ‘Operation Twist” is faring before moving again but recent indications from some Fed officials suggest growing support for purchases of mortgage backed securities.

On the data front eurozone inflation today will be the key number in Europe while the US jobs report at the end of the week will be the main release in the US. Ahead of the payrolls data, clues will be garnered from the ISM manufacturing data and ADP jobs report. The consensus is for a 95k increase in non-farm payrolls and the unemployment to remain at 9.1% maintaining the trend of only gradual improvement in the US jobs market.

Recent data releases have turned less negative, however, and at the least have helped to alleviate renewed recessionary concerns. Overall, I suspect that markets will come back down to the reality of slow growth and unanswered questions this week, with risk assets likely to lose steam over coming days.

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