US Dollar, Japanese Yen Diverge as US Trade Deficit Widens – US Retail Sales Could Reflect Slight Increase

The US dollar was the weakest of the majors on Tuesday, while the Japanese yen proved to be the second strongest, as USD/JPY plunged more than 1 percent. Based on the fact that US equities spent most of the day in negative territory but ended the day on a mixed note (DJIA +0.6 percent, S&P 500 -0.1 percent), the currency market moves suggest that the US dollar may be losing its safe-haven luster. US economic news certainly didn’t work in favor for the greenback after data showed that the US trade deficit widened for the first time in eight months during March by 5.5 percent to $27.6 billion. A breakdown of the report shows that exports slumped 2.4 percent to a more than two-year low of $123.62 billion while imports fell 1.0 percent to $151.196 billion. According to Bloomberg News, the Commerce Department used a much larger increase in exports when calculating Q1 GDP, suggesting that initial estimates of a 6.1 percent annual contraction could be revised even lower.

That said, Friday’s price action throughout the FX markets was extremely volatile and yielded sharp moves, but what we’ve seen over the past two day may represent more of a consolidation rather than a indication of a new trend, where the US dollar loses its inverse correlation with risky assets. However, if we see these moves continue, fundamental (the dismal US economic outlook) and technical (the DXY index’s drop below key trendline support) factors may work in favor of further US dollar declines, whereas breakdowns in the Japanese yen crosses may signal additional gains for the yen.

Looking ahead to Wednesday, the Commerce Department is forecasted to report that US retail sales stagnated in April, after tumbling 1.2 percent in March. However, there is potential for a better-than-expected result, as the latest ICSC chain store sales numbers show that consumption rose 0.7 percent in April from a year ago, marking the first increase since September 2008. Furthermore, initial estimates of US Q1 GDP showed that personal consumption rose 2.2 percent during the quarter, suggesting that aggressive discounting by retailers has been able to offset some of the negative impact of deteriorating labor markets, tight credit conditions, and a lingering recession.

British Pound Gains Amidst Slight UK Trade, Employment Improvements - Watch BOE Inflation Report on Wednesday

The British pound made headway this morning, leading GBP/USD up for a test of 1.5350 and EUR/GBP down below Monday’s lows near 0.8955, as UK economic releases proved to be better than expected. Looking at the first round of reports at 04:30 ET, the UK’s visible trade deficit narrowed to -6.589 billion pounds in March from -6.834 billion pounds, marking the second straight improvement. The shift was due to a combination of two factors: increased exports to non-EU27 nations and a slight decline in imports. Meanwhile, industrial production fell less than anticipated at a rate of -0.6 percent as manufacturing output only fell 0.1 percent, the best reading since the component was in positive territory just over a year ago. Nevertheless, the annual rate of industrial production growth still plunged 12.4 percent, the sharpest contraction since record-keeping began in 1949.

The second round of releases at 09:00 ET was completely unexpected, as they were scheduled to hit the wires on Wednesday at 04:30 ET, but the news wasn’t too influential in the currency’s daily price action. The Office for National Statistics said that the UK’s claimant count level rose by 57,100 in April, bringing the total up to 1.513 million and the claimant count rate up to an 11-year high of 4.7 percent. While the rise in the claimant count rate wasn’t as large as expected (Bloomberg News was calling for a jump of 85,000), the data was nearly optimistic enough to warrant speculation about any sort of turnaround in UK growth. Tomorrow’s release of the Bank of England’s Quarterly Inflation Report has the potential to highlight this point. Indeed, the BOE’s latest policy statement indicated that they decided to expand their quantitative easing program by 50 billion pounds to 125 billion pounds, suggesting that this inflation report could reflect steep downward revisions to growth and inflation forecasts. If this proves to be the case, the British pound could pull back very sharply.

Canadian Dollar Ekes Out Gain vs US Dollar as Canadian Trade Surplus Expands

The Canadian dollar initially rallied on news that Canada’s trade surplus expanded more than expected, as the balance reached C$1.1 billion in March, up from a revised C$262 million in February. However, USD/CAD quickly recovered from its morning low of 1.1540 throughout the US trading as the increase in the balance had more to do with the downturn in imports rather than a rise in exports. Indeed, shipments abroad fell by 1.8 percent to C$32.503 billion while Canadian demand for foreign goods fell by 4.4 percent to more than 5-year low of C$31.398 billion. Ultimately, it’s clear that Canadian consumer and business spending is lackluster, but so long as it doesn’t contract to the degree it has in regions like the US and Europe, the fundamental view for the Canadian dollar will remain significantly better compared to some of its major counterparts.

Euro Lags Ahead of Friday’s Euro-zone Q1 GDP Report

The euro lagged against many of the majors, including the Japanese yen and British pound, but EUR/USD held above support at 1.3600. There was little in the way of economic news, but the euro could encounter some bearish data on Friday as Q1 GDP is forecasted to contract for the fourth straight quarter, this time at a rate of -2.0 percent, compared to -1.6 percent in Q4 2008, while the year-over-year rate could fall by a whopping 4.1 percent. Such data would indicate that the Euro-zone’s recession deepened into the start of 2009, and would only raise the odds that the European Central Bank will consider cutting rates further or will need to take more drastic steps than their current credit easing plan.

Terri Belkas is a Currency Strategist at FXCM.