3 Things That Could Shake Up the Dollar on Tuesday

No US economic data was released this morning explaining the listless action in the US dollar. Traders are hesitant because they know that things could change dramatically with the 3 event risks tomorrow that could shake up the US dollar. The first is the retail sales report for the month of June. Despite a deteriorating labor market and rising food and energy prices, consumer spending should remain positive. Discounters like Wal-Mart, Costco and Target all reported stronger sales last month, indicating that even though consumers may be trading down, they are continuing to spend their tax rebates. As long as consumer spending does not collapse, there may still be some hope for the US economy. Both the ICSC and SpendingPulse reports also support stronger spending numbers. Excluding autos, SpendingPulse reported that sales rose by the largest amount in 7 months. A stronger retail sales report however may be eclipsed by Bernanke’s semiannual testimony on the economy and monetary policy. The Fed Chairman should remain hawkish on inflation, but he will be forced to address the latest problems in the financial sector. Expect Bernanke to come under significant pressure during the Question and Answer session for solutions to the latest financial market turmoil. It doesn’t help that going into the testimony, the Dow is trading near its 2 year lows. Unfortunately no one is convinced that the Fed’s offer for Fannie Mae and Freddie Mac to access the discount window or the Treasury’s attempt to seek Congressional Approval for an investment and larger credit line will be enough. The VIX, which is the CBOE’s volatility index hit a 3 month high today, indicating that the market is still nervous and skeptical about the effectiveness of the US government's latest announcements. They rightfully believe that the Fed is running out of magic bullets. In order to avert another panic, the Fed needs to shock the markets, just as they did last year with aggressive easing. The failure of mortgage lender IndyMac was also a big story today and with JPMorgan, Merrill Lynch and Citigroup reporting earnings at the end of the week, the health of the financial sector should continue to dominate the headlines. Finally, keep an eye on producer prices since inflation is the primary reason why the US central bank has given up on cutting interest rates.

Euro Retraces but Still Aiming for Record Highs

The euro gave back some of its recent gains as industrial production falls by the sharpest amount in 20 years. This was widely expected given previous reports of slower manufacturing activity in France and Germany. However despite clear signs of slower growth, ECB Member Bini Smaghi was crystal clear about the central bank’s priorities in an article to the Financial Times on Friday. He said that the slowdown in the productivity is not enough to take their focus off of inflation. If domestic inflation does not come down, there is only one option left, which is monetary policy and all should be aware that the central bank must ultimately act if this is what is needed to maintain price stability. For this reason, the EUR/USD could continue to rise towards its record highs. The German ZEW survey of analyst sentiment is due for release tomorrow. Given the recent rate hike and turn in economic data, we expect analysts to be more pessimistic.

British Pound Races Higher as PPI Grows by Fastest Pace in 22 Years

The British pound strengthened against the US dollar, Euro and Japanese Yen as producer prices grew by the fastest pace in 22 years. The annualized pace of PPI growth jumped to 10 percent last month even though the monthly pace slowed. Tomorrow we will find out whether producers have been able to pass on a good portion of the burden of record oil prices onto consumers. Inflation is the only reason why the Bank of England has not cut interest rates as their economy continues to slow. They are in a very difficult situation now because they want to cut rates. BoE member Barker said this morning that "The mistake we could make, and we are all worried about this, is of holding policy too tight, and the economy weakening more than is necessary to get inflation back on target." Meanwhile BRC retail sales and the RICS house price balance are due for release this evening – which could take some steam out of today’s British Pound rally.

Australian Dollar Hits New Highs

The commodity currencies all raced higher today, but the story is undoubtedly in the Australian dollar. The Aussie hit a new 25 year high against the US dollar and a 7 year high against the New Zealand dollar. Although there was no Australian data released overnight, the country’s diverging economic performance with the US and New Zealand has sent money pouring into Australian dollars. Retail sales in New Zealand fell by their steepest pace in over 4 years while the manufacturing PMI index contracted for the third time in four months, adding to signs that the New Zealand economy is in for a recession. NZD Consumer prices are due for release this evening along with the minutes from the RBA’s most recent monetary policy meeting. These numbers should continue to lift AUD/NZD.

EUR/JPY Hits Another Record High

The Euro hit another record high against the Japanese Yen as growing concerns in the US economy continue to push the US dollar lower against the Euro. Given the drop in USD/JPY, the rise in EUR/JPY is 100 percent a Euro story. The Bank of Japan has a monetary policy decision this evening. With consumer confidence and growth deteriorating at the same time that inflation is rising, the BoJ has no room to move on interest rates. This should keep pressure on the Japanese Yen against all of the major currencies. The fate of USD/JPY will depend on whether the losses in the stock market continue.

Kathy Lien is the Chief Currency Strategist at FXCM.