Another Big Surprise for the Dollar

The currency market was fairly quiet today with the US dollar rallying against some currencies and falling against others. Jobless claims were the only piece of data released and filings for unemployment dropped by 58k to the lowest level in 3 months. The goods news however was shrugged off by the markets because the data is distorted by seasonal shutdowns in auto plants. This happens every summer in the month of July and lasts for about two weeks. According to the Labor department, their seasonal adjustment formula prices in auto layoffs in the first 2 weeks of July and fewer occurred last week than expected. Excluding the seasonal adjustment, claims actually increased by 30k while continuing claims rose by 91k. With companies such as Starbucks, Citigroup and Air Tran announcing layoffs in the past month, the labor market will worsen before it improves. Despite the bad news, the US dollar may be in for a big surprise. A difficult labor market, the decline in the stock market and the rise in food and energy prices are expected to force US consumers to reduce spending. However judging from the monthly reports from retailers, consumer spending may not be that bad. Discounters like Wal-Mart, Costco and Target all reported stronger sales in the month of June as consumers continue to spend their tax rebates. If retail sales remain positive, the US economy may avoid double dipping, which would be a nice surprise for the US dollar. Fannie Mae and Freddie Mac’s potential solvency problems were the biggest news in the financial markets today. They are too big to fail and we believe that the US government will exhaust their options before allowing this to happen because preventing or mitigating future crisis is Bernanke and Paulson’s top priority. Fed President Yellen even said today that the Fed has the potential to further ramp up facilities if needed. Meanwhile the US trade balance and consumer confidence reports are due for release tomorrow. The rise in the export component of the manufacturing ISM report suggests that the trade balance will improve, but any dollar rally could be offset by the consumer confidence report which will be released shortly thereafter. More strain on the US economy should lead to weaker consumer confidence.

Eurozone Growth Continues to Slow

The Euro strengthened against the US dollar but that does not correctly reflect the outlook for the Eurozone economy. French and Italian industrial production both dropped significantly in the month of May which is consistent with the decline that has already been reported in Germany and Spain. Based upon these numbers, GDP should have remained unchanged in the second quarter, which compares to the 0.7 percent growth reported in Q1. The Eurozone economy is undoubtedly struggling and the catalyst that will break the EUR/USD out of its current range is evidence that one economy (the US or the Eurozone) is deteriorating much faster than the other. This could very well be the Eurozone, which is only beginning to suffer. There will be no Eurozone economic data due for release tomorrow, which means that the price action of the currency pair will depend upon US data and the fluctuations in the Dow.

Bank of England Meeting: A Big Yawn

The Bank of England meeting was a big yawn as interest rates were left unchanged at 5 percent. The lack of a surprise statement or a rate cut came as a relief to some pound traders who were hoping for the impossible – a proactive move by the BoE. Historically, the BoE has been a very dynamic central bank that keeps the market guessing, but after Mervyn King fell behind the curve in responding to the credit crunch in August 2007, he hasn’t quite caught up. The British pound did end the day lower against the Euro and US dollar, but that was largely due to selling at the London open. The UK housing market continues to be the Achilles Heel of the UK economy. Mortgage lender Halifax report a 6 percent drop in house prices compared to a year ago, which translates into a 2 percent drop from the pervious month. Similar to the conditions in NY, the housing market is closely tied to the labor market. When the layoffs in financial sector finally hit, the housing market could deteriorate even further.

Australian Dollar Rises on Stronger Employment Numbers, Next Up is the Canadian Dollar

The best performing currencies today were the Canadian, New Zealand and Australian dollars. Despite the drop in the employment component of the service and manufacturing PMI report, job growth in Australia increased more than expected in the month of June. The 29k rise completely reversed the 25k drop from the previous month. Although the Australian labor market is in far better shape than the labor market in the US, the sharp jump is partially attributed to a smaller sample size. Canada will be releasing employment numbers tomorrow. Consumer confidence has been plummeting, but the sharp rise in the IVEY PMI report suggests that traders should not rule out good numbers. Finally, the New Zealand dollar is higher despite a decline in the business PMI index.

Japanese Yen Crosses Rebound Despite Volatility in US Stocks

The Japanese Yen crosses continue to be at whim of the US stock market. The Dow was up more than 100 points after lunchtime in NY but then reversed all of those gains to hit a low of 11086.95 (-62 for the day) before ending up 81 points. This type of rollercoaster ride is something traders have unwillingly grown accustomed to this past week as 100 point swings in either direction become the norm. The CGPI index, trade and current account balances were better than expected, but as we have suggested, these numbers had little impact on the Yen. Consumer confidence is due for release tonight and they should be weak, just like the Eco Watchers survey.

Kathy Lien is the Chief Currency Strategist at FXCM.