Stocks Drop But Is This the End of the Dollar Rally?

The US stock market dropped more than 230 points today, dragging the US dollar down with it. There was no US data released today and the primary explanation for the drop in stocks is the rise in oil and concerns about the seizure of two banks by the FDIC this weekend. First Nation Bank and First Heritage Bank are small, but the failure of any bank is significant since their problems are not unique and could foreshadow similar problems for other financial institutions in the future. However despite today’s move, the dollar’s rally may not be over. We like to keep a close eye on gold prices and so far, they are flat on the day and trading near their monthly lows. This suggests that risk appetite remains steady which explains the tepid sell-off in the US dollar. Last week, micro and not macro drivers impacted the US dollar. Bank earnings, movements in stocks and the fluctuations in oil prices (which can fit into macro) kept the dollar near the top of its monthly range. This week, it will be a tug of war between micro and macro drivers with earnings season in full swing. Consumer confidence and the S&P / CaseShiller house price index are due for release tomorrow. Given the improvement in the University of Michigan consumer confidence numbers last week and the mixed housing market numbers, upside surprises could be in store for tomorrow. The market’s pain threshold for bad data seems to be rising since the news about the two bank seizures should have elicited a bigger reaction in the US dollar because it indicates more trouble for regional banks. With that in mind, GDP and non-farm payrolls are due at the end of the week. Strong retail sales in the second quarter will keep GDP in positive territory and at least for another quarter, a recession will have been avoided. There is no question that non-farm payrolls will be weak, but if dollar bulls are really more tolerant of pain, the seventh consecutive month of negative job growth may only have a limited impact on the US dollar.

Euro: German Consumer Confidence Hits 5-Year Low

The Euro strengthened against the US dollar but economic data continues to take a turn for the worse. German consumer confidence fell to the lowest level in 5 years as income expectations plummet. Germany is the largest country within the Eurozone and we are beginning to see broad based weakness. It should just be a matter of time before consumer spending which jumped 1.3 percent in the month May starts to turn negative as well. Retail sales are due for release over the next week. The US economy is still in trouble, but this “new” deterioration in the Eurozone will only accelerate. Continual weakness in Eurozone economic data will not only cap the recovery in the Euro, but also help lead the US dollar higher. All of the high yielding currencies have fallen significantly against the US dollar over the past week. It makes you wonder if the Eurozone economy is in worse shape than Australia or Canada, why has the drop been so limited. The answer is that it may just be a matter of time before the EUR/USD comes in balance with the rest of the market. French producer prices are the only piece of Eurozone economic data on the calendar tomorrow that is of any consequence. Switzerland will be releasing the UBS consumption indicator – weaker numbers are expected, but the Swiss economy is still faring better than many of its G10 counterparts.

British Pound Edges Higher But Gains Should Be Limited

The British pound edged higher against the US dollar today but the gains should be limited. In fact, the pound only rallied against the dollar as the currency lost ground to the Euro, Japanese Yen and Swiss Franc. There was no UK data released today, but the outlook for this week’s data hangs over the currency. Consumer credit, mortgage approvals and net lending are all due for release tomorrow. The housing market is the Achilles Heel of the UK economy and so far there is no respite in sight. We fully expect the housing market data to remain weak and to weigh on the British pound. For the UK, a recession could still be looming. The consumer confidence and manufacturing PMI numbers due later this week will provide more insight into whether the prospect of a recession will soon become a reality.

Australian, New Zealand Dollar Recover, Canadian Dollar Continues Lower

The Australian and New Zealand dollars have recovered on mixed economic data and broad dollar weakness. House prices in Australia rose 4 percent last month after dropping 5 percent the previous month. The number of new homes sold also rose marginally. Despite this good news, Australian business confidence has dropped to the lowest level in 17 years. The burden of lower consumer confidence, slower global growth, rising prices and falling equity prices has become too much for the average Australian business to handle. In contrast, the New Zealand dollar recovered nicely as the trade deficit came out better than expected. Although the deficit did rise, imports and exports both increased. Meanwhile the Canadian dollar has fallen for the fifth trading day in a row. The fear is that the drop in oil prices will bring forward the problems within the Canadian economy. For a long time, high oil prices have masked a slowdown in export demand.

Yen Crosses Tumble on Equity Market Weakness

The weakness in the US equity market drove all of the Japanese Yen crosses lower. Even though we have a very busy Japanese economic calendar this week, the equity markets will continue to dominate the price action of the Yen crosses. This has been the case for the past few months and will continue to be the case for the foreseeable future. Consumer spending and labor market data are due for release this evening. The labor market should hold steady, but retail sales is expected to fall significantly as the rise in prices takes a big bite out their discretionary spending.

Kathy Lien is the Chief Currency Strategist at FXCM.