US Dollar Rally Stalls on Dovish Fed Commentary, Ahead of Advance Retail Sales

The US dollar rally stalled out against the Euro, Japanese yen, and Canadian dollar on Tuesday amidst somewhat-dovish commentary by Minneapolis Fed President Gary Stern. During an interview with CNBC, Mr. Stern said that “some of the concerns about inflation and some inflation expectations seem to have diminished,” which removes much of the logic behind speculation of rate increases by the Federal Reserve. In fact, overnight index swaps are still pricing in 86bps worth of hikes within the next 12 months, but data releases on Wednesday and Thursday may shake these forecasts up. Advance Retail Sales are expected to slip 0.1 percent in July and the index that excludes auto sales is forecasted to increase 0.5 percent, as consumers continue to spend, albeit at a slower pace. However, there is downside risk for this report, as we also have to consider the fact that average gasoline prices fell throughout the latter part of July from over $4/gallon. In recent months, the surge in gas prices alone has helped lift the overall index since it is not adjusted for inflation. Thus, recent declines could actually weigh on the headline reading and pushed Advance Retail Sales deep into negative territory for the first time in five months. Meanwhile, US import price growth is anticipated to slow thanks to the appreciation of the greenback, which may weigh on the US dollar slightly. From a technical perspective, the US dollar index is still holding below a falling trendline which connects the late 2005 – 2007 highs, adding to evidence that the greenback could ease lower on Wednesday. However, that is not to say that the currency won’t be able to gain against some majors, as GBP/USD broke below critical support on Tuesday at the 200 SMA at 0.9022, signaling the pair is likely to continue falling to ultimately test 1.85.

Euro Successfully Holds Above 2007 Highs

Despite an early-morning plunge to 1.4815, the Euro managed to recover during Tuesday’s US trading session and as of the NY close, EUR/USD was successfully holding above the 2007 highs near 1.4880/1.4900. However, overnight index swaps are still pricing in over 25bps worth of rate cuts by the European Central Bank and over 75bps worth of rate hikes by the Federal Reserve within the next 12 months. As long as the markets are betting on such interest rate probabilities, EUR/USD will have difficulty accumulating substantial gains. Event risk for the pair is contingent upon the previously mentioned US data on Wednesday, but caution should be paid to Thursday’s Euro-zone releases as GDP and CPI have the potential to shake the Euro up significantly. Until then, my fundamental bias for the Euro on Wednesday is bullish. Looking at the daily EUR/USD charts, the long lower wick on Tuesday’s candle suggests the pair may have hit a short-term bottom.

British Pound Breaks Key Support, More Declines May Be In Store

The British pound finally managed to break below the 200 SMA on the weekly charts at 1.9022, a level which the pair has held above since June 2002. Perhaps the most surprising part of this is that UK CPI was stronger than expected this morning, as the annual rate accelerated to 4.4 percent. This is not only the highest level since comparable records began in 1997, but is also well above the Bank of England’s 2 percent target and 3 percent upper limit. The data puts the BOE Monetary Policy Committee in an even worse position, as robust price pressures calls attention away from widespread indications of a sharp UK economic slowdown. Last month, the majority of the MPC members voted to leave rates steady, but there was one vote in favor of a 25bp hike and one in favor of a 25bp cut. Currently, overnight index swaps are pricing in 44bps worth of cuts within the next 12 months, down from 52bps last Wednesday. Clearly, these UK CPI numbers haven’t had an extreme impact on rate expectations, but Wednesday’s release of the BOE’s Quarterly Inflation Report might. This has great market-moving potential as it will serve as a more timely view of the MPC’s bias (the August 7 meeting minutes will not be released until August 20). Everyone knows that inflation is a problem in the UK, but if the Bank’s GDP projections are revised down, this news would support the case for a British pound decline toward 1.8500.

Australian Dollar, New Zealand Dollar Plunge As Demand For Yield Wanes

The Australian dollar and New Zealand dollar both plunged during Tuesday’s trading session as high-yielding currencies were sold off sharply. While the correlation between carry trades and the DJIA is not as strong as it once was, according to our latest forex correlations report, the price action throughout the financial markets was indicative of risk aversion and deleveraging. Indeed, the DJIA plummeted 1.19 percent, demand for Treasuries rose, leading yields lower, commodities like gold and oil fell, while the Japanese yen rallied across the majors. On the other hand, the Canadian dollar snapped its losing streak following the release of Canadian trade figures on Tuesday morning. In fact, the Canadian international merchandise trade balance rose to C$5.8 billion from C$5.2 billion as US demand for exports jumped 5.3 percent in June. The data suggests that the export industry may help support Canadian expansion, but since this is such a lagging indicator, it may not be worth putting too much stock in this sort of sentiment. There are no major releases due for the commodity dollars overnight, though a jump in the Australian Wage Cost Index for Q2 could help to provide the beleaguered Aussie with a boost. Nevertheless, the trend for AUD/USD and NZD/USD remains bearish.

Japanese Yen Rockets As Risk Aversion Makes a Comeback

As we mentioned in our discussion of the Australian dollar and New Zealand dollar, risk aversion returned on Tuesday, weighing heavily on high-yielding currencies and rewarding the low-yielding Japanese yen. In fact, the Japanese yen gained a whopping 1.89 percent against the Aussie, 1.45 percent against the British pound, and 1.2 percent against the Kiwi. That said, there is still downside potential for the Japanese yen crosses, including USD/JPY, this week.

Terri Belkas is a Currency Strategist at FXCM.