Dollar Saved by Retail Sales
US retail sales decreased 0.2 percent in the month of April, but the US dollar skyrocketed as there was strength beneath the headline number. Excluding autos, sales actually increased 0.5 percent and despite the rise in gasoline prices, gas station receipts actually fell. This suggests that Americans are driving less and buying fewer cars. This weekend, the NY Times reported that gas prices are sending a surge of riders to mass transit and the details of the retail sales report confirm that. Consumers increased their spending on building materials, electronics and clothing. As indicated in yesterday’s Daily Fundamentals, earnings for many discount retailers including Wal-Mart t have surprised to the upside and there were many reasons to believe that retail sales was not exceptionally weak in April. According to Ken Perkins of Retail Metrics Inc, April was the best month for retailers since November. What we have seen today is weak job growth does not always translate into weak consumer spending. In October 2001, when non-farm payrolls dropped 325k, retail sales actually jumped 6.6 percent. It is important to remember that the index can be very volatile on a month to month basis. The number gives traders more reason to be dollar bullish in the near term, but don’t lose sight of the fact that there are still many risks to consumer spending. Meanwhile import prices rose 1.8 percent to an all time high of 15.4 percent, reflecting the global increase in inflationary pressures. US consumer prices are due for release tomorrow and we believe that consumer prices will follow import and producer prices higher. In today’s Wall Street Journal, there is an article about rising shoe prices. The combination of higher production costs in China, which makes about 85 percent of the shoes sold in the US and higher fuel prices, is forcing many footwear makers to raise prices. This trend is evidence of inflation hitting core consumer prices and despite the article in the WSJ; the shoe industry is not the only ones to have increased prices.

Eurozone Economic Calendar Heats Up
Since the beginning of the month, the Euro has been trading in a relatively tight range against the US dollar. There has been no major Eurozone economic data released so far this week, leaving the single currency at the whims of US data. Today, the Euro gave back its gains against the greenback following the dollar bullish US retail sales report. However with the economic calendar heating up for the Eurozone starting tomorrow, the region’s economic performance could once again start having its influence on the Euro. Tomorrow we have Eurozone industrial production and French consumer prices. Even though CPI could be stronger, industrial production is expected to drop as there was a similar decline in activity in France and Germany. On Thursday we are expecting Eurozone GDP and consumer prices, followed by the trade balance on Friday. Hawkish comments from ECB President Trichet cemented a near term bottom in the Euro last week. For the time being, further losses should be limited until we see a meaningful deterioration in Eurozone economic data.

British Pound Fails to Rally Despite Inflationary Pressures
The British pound’s failure to rally on the stronger than expected consumer price report is a testament to the market’s bearishness towards the pound. Inflation is rampant and it will continue to prevent the central bank from aggressively easing monetary policy. The Bank of England’s Quarterly Inflation report is due for release tomorrow and we expect the central bank to recognize the tough decision that they have at hand. Most likely they will tell the markets that they have no choice but to defer rate cuts. This may conflict with the employment report which is due an hour before the inflation report. London has been hit particularly hard by the financial market turmoil, forcing many investment banks to announce layoffs. The employment components of the service and construction sector PMI reports also declined, confirming our belief that the labor market in the UK has weakened. Soft numbers could offset any bullishness that may come from the Quarterly Inflation Report.

Australian and New Zealand Dollars Weaken, Canadian Dollar Holds Onto Gains
The strength of the US dollar and the retracement in gold prices has driven the Australian and New Zealand dollars lower. The only piece of data released from the 3 commodity producing countries was New Zealand food prices which were weaker than expected. The strength of the currency since the beginning of the year has helped to offset the rise in food prices which is something that countries like the US may be hoping for. The Canadian dollar on the other hand was the only currency that managed to strengthen against the US dollar as oil prices hit a new record high. With no major Canadian data scheduled for release this week, the primary trigger for any fluctuations in the loonie would be US data or oil prices.

USD/JPY Takes Aim at 105
Despite today’s drop in US stocks, Japanese Yen crosses continued to edge higher. USD/JPY took a stab at hitting 105, stopping short of that psychologically significant resistance level by a mere 10 pips. The rally in the dollar and the drop in gold prices suggest that the market’s risk appetite is improving. The VIX, which is a measure of equity market volatility actually dropped to the lowest level since October 2007. Carry trades thrive in low volatility environments which is a big reason why the yen crosses have been rebounding. 105 could be difficult for USD/JPY to break, especially if volatility reverts back to more normal conditions and the markets suddenly become risk averse once again.

Kathy Lien is the Chief Currency Strategist at FXCM.