US Dollar Tumbles As Leading Indicators Plunge - Fed’s Bernanke Speaks on Friday

The US Dollar pulled back across the majors this morning as the overbought currency finally shows signs of correction. The release of the Conference Board's US leading indicator triggered the move as the index of 0.7 percent in July, which mark the worst drop since the credit crunch began at the end of last summer. Looking at a breakdown of the index, rising jobless claims and deteriorating building permits and stock prices all took a toll. However, the declines are not entirely surprising given the broad losses in the labor markets, housing sector, and equity markets. Meanwhile, Credit Suisse overnight index swaps are showing diminishing rate hike expectations for the Federal Reserve over the next 12 months, as they now price in 56bps of increases compared to over 75bps just a week ago. Furthermore, the latest forex positioning numbers show that the US dollar is likely to weaken before continuing its rally.

Additional event risk looms on Friday at 10:00 EDT, when Federal Reserve Chairman Ben Bernanke will speak on financial stability at the Kansas City Fed’s annual symposium in Jackson Hole, WY. His commentary tends to ignite major volatility for not only the greenback, but also for US Treasury and equity markets (and thus, the Japanese Yen crosses). Given the uncertainty surrounding the health of US financial institutions, commentary on the financial markets will be watched closely and bearish sentiment by Mr. Bernanke could weigh heavily on risk-appetite. On the other hand, if Mr. Bernanke signals optimism that the US economy and financial sector can weather the storm, the US Dollar and risky assets, in general, could gain.

British Pound Rebounds As UK Retail Sales Surge – But Did They Really?

The British Pound recovered on Thursday and managed to break above resistance at 1.87 as UK consumer spending surprisingly improved. Indeed, retail sales jumped 0.8 percent in July versus a whopping 4.3 percent decline during the month prior. Looking at a breakdown of the index, spending trends appear to be evolving in a manner similar to that of the US, as consumers divert spending away from department stores and discretionary items to discount stores and necessities. However, according to comments by the Bank of England last week, the central bank doesn’t have much faith in these official numbers and as a result, I don’t either. In fact, the BOE said they placed “a rather greater weight than usual” on survey data since it was a less volatile measure. The latest survey numbers – BRC retail sales – showed a 0.9 percent drop in same-store sales in July from a month earlier, which sounds a bit more believable as the UK economy slows dramatically. Looking ahead to Friday, the second reading of UK GDP for the second quarter will be released, and the annual rate is anticipated to be revised down to a more than 15-year low of 1.5 percent from initial estimates of 1.6 percent. A reading in line with expectations shouldn’t be too market-moving, but if GDP misses forecasts, choppy price action for GBP/USD should ensue.

Euro Rises Despite Signs of Euro-zone Recession

The Euro surged higher on Thursday despite the fact that European economic data remains broadly disappointing. In fact, the Euro-zone services and manufacturing PMI reports both remained 50 – signaling a contraction in business activity – for the third consecutive month in August. Indeed, businesses and consumers alike appear to be cutting back on spending amidst high energy costs, tight credit conditions, and waning global demand. This is much of the reason why Credit Suisse overnight index swaps are pricing in over 25bps worth of rate cuts within the next 12 months, which leaves the Euro prone to further declines in the medium to long-term. However, given the oversold nature of currency and current forex positioning, EUR/USD may be prone to additional gains in the short-term, though 1.4960/1.50 should provide solid resistance.

Gold, Oil Rallies Propel the Commodity Dollars Higher, Canadian CPI Hits 5+ Year High

The Australian Dollar, New Zealand Dollar, and Canadian Dollar all surged higher on Thursday, aided by a weak US dollar, a 4.9 percent jump in oil futures and a 2.8 percent gain in gold futures. Meanwhile, the headline reading of Canadian CPI accelerated 3.4 percent in July from a year earlier, marking the sharpest gain since March 2003. As usual, the index was led by volatile energy and food costs as the Bank of Canada’s core measure actually held steady at 1.5 percent. Nevertheless, Credit Suisse overnight index swaps have shifted to price in 30bps worth of rate cuts by the Bank of Canada within the next 12 months, compared to over 50bps earlier in the week. Looking toward Friday though, commodity currencies will likely remain contingent upon oil and gold prices, especially since there is no data scheduled to be released.

Japanese Yen: Bernanke May Make or Break Carry Trades On Friday

The Japanese Yen rallied across the majors early this morning as European stock markets opened sharply lower, adding to already-jittery sentiment in the global markets. The low-yielder subsequently pulled back later in the day, though it failed to do so against the US dollar. Indeed, broad weakness in the greenback weighed quite heavily on the USD/JPY pair, and it is worth noting that downside risks remain for the Japanese yen crosses linger. The financial markets remain on edge, especially on concerns about the health of the two US mortgage giants Fannie Mae and Freddie Mac, and with Federal Reserve Chairman Ben Bernanke scheduled to speak on financial stability on Friday morning, risk sentiment could be severely affected. Thus, traders should continue to keep an eye on technical levels, as the Japanese yen tends to obey them over Japanese fundamentals.

Terri Belkas is a Currency Strategist at FXCM.