US Dollar - Is This Reversal Just the Beginning of a Bigger Move?

The US dollar fell sharply across the majors on Friday as US retail sales and producer prices proved to be broadly bearish and unsupportive of speculation that the Federal Reserve is hawkish enough to consider raising interest rates before year end. US Advance Retail Sales fell more than expected by 0.3 percent in August, marking the second consecutive month of contraction. Looking at a breakdown of the index, spending in nearly every component declined, led by building materials, gasoline stations, and department stores. It is worth noting, though, that this index is not adjusted for inflation, so the drop in the gasoline station component may only be indicative of the drop in gas prices during August (rather than a drop in demand). Nevertheless, consumption is widely anticipated to be a soft spot for the US economy going forward, as the housing sector has yet to recover for some time, credit conditions remain tight, and the unemployment rate rises. In fact, during August, the unemployment rate surged to a 5-year high of 6.1 percent with non-farm payrolls contracted for the eighth consecutive month.

Looking at the other release on hand, US producer prices fell by the most in nearly 2-years during August, as the index tumbled 0.9 percent for the month and slowed to an annual pace of 9.6 percent from 9.8 percent. The decline was led, unsurprisingly, by energy as crude oil plummeted over the course of the survey period. However, excluding this fact, producer prices rose 0.2 percent during the month thanks to continued food cost increases. Overall, the data should quell some of the speculation that the Federal Reserve will move to raise rates before year end, as we actually saw that fed fund futures were pricing in a slight 14 percent chance of a 25bp cut at the next meeting on September 16. While this is highly unlikely, that sort of sentiment was just what dollar bears needed to get back in the game and this move could continue throughout next week, though much of that will depend on the Federal Reserve’s policy statement on Tuesday and what sort of bias it reflects.

British Pound Rockets 2% Higher, More Gains May Be In Store

There was no UK data on hand on Friday, but if there had been, it probably would’ve been disappointing. Indeed, there’s no doubt in anyone’s mind that the Bank of England is in a very tough spot at this juncture, as the UK economy teeters on the brink of recession while inflation pressures remain strong. That doesn’t mean the British pound can’t gain in these circumstances though. It took a few days, but my DailyFX Analyst Pick from Monday is finally working out, as GBP/USD rocketed higher on Friday as the overextended decline in the pair finally started to correct. According to the latest FXCM SSI numbers, GBP/USD shorts jumped 16 percent, and as a contrarian indicator, the data signals additional gains. While my bias for the British pound remains bullish for much of next week, the currency faces hefty event risk. On Tuesday, UK CPI is expected to accelerate even faster to a 4.6 percent annual pace, which would mark the sharpest rise since May 1992. On Wednesday, the Bank of England’s meeting minutes - a huge market-mover for the British pound – will hit the wires and could show yet another split vote and biased commentary. Finally, on Thursday, UK retail sales are forecasted to fall 0.5 percent, dragging the annual rate to a more than two year low of 1.6 percent and adding to the pile of evidence signaling a potential recession.

Euro Rallies 200+ Points, Breaks Trendline Resistance

The Euro rallied extended 2.3 percent higher against the Japanese yen and 1.6 percent versus the US dollar as the oversold currency finally reversed. In fact, looking at recent FXCM SSI readings, EUR/USD positioning flipped from net long to net short on Friday, and as a contrarian indicator suggests the pair could gain further. However, there is still quite a bit of rate cut speculation, as Credit Suisse overnight index swaps are now pricing in nearly 50bps in reductions by the ECB over the next 12 months, compared to 25bps in cuts just two weeks ago. Thus, from an interest rate perspective there’s still downside risk for the euro, and there is notable resistance looming above at the 38.2% fib of 1.4812 – 1.3880 at 1.4236. While I do see potential for EUR/USD to pullback when trading resumes on Sunday, my bias for the euro remains bullish for much of next week.

Japanese Yen: The Only Currency Weaker Than the US Dollar

Like the US dollar, the Japanese yen tumbled across the majors, but losses for the low-yielding yen were hefty as the currency lost nearly 3 percent against high-yielders like the British pound and Australian dollar. The move had more to do with sharp reversals in oversold currencies like the Euro and British pound, but with the Japanese Yen interest rate forecast looking neutral, the currency will be particularly vulnerable to choppy price action. Meanwhile, Japanese data was extremely weak overnight as the final revision of Q2 GDP confirmed that the world’s second-largest economy shrank 0.7 percent during the quarter and contracted 3 percent from a year earlier. Since Q1 GDP fell 0.6 percent, Japan is now officially in recession (strict definitions of recession refer to two consecutive quarters of negative economic growth). As a result, the Bank of Japan will likely stick to a loose monetary policy by keeping borrowing costs unchanged at 0.50 percent through the next year, though BOJ Governor Shirakawa’s scheduled speech late next week could yield some bearish commentary on the economy.

Terri Belkas is a Currency Strategist at FXCM.