US Dollar, Japanese Yen Fall as S&P 500 Breaks Above 200 SMA

The US dollar and Japanese yen both fell lower on Monday, though the latter was the weakest of the majors, as investor sentiment continued to build despite the fact that General Motors Corp. unsurprisingly filed for bankruptcy protection, reporting $82.3 billion in assets and $172.8 billion in debt, with the US government set to hold a 60 percent stake in the new entity by converting the bulk of its $50 billion worth of loans. Indeed, risk appetite was so strong that the DJIA rallied 2.6 percent for a test of its 200 SMA at 8765 while the S&P 500 also jumped 2.6 percent, breaking above its 200 SMA at 927, but closing below its former 2009 high of 943.85.

Looking to the day’s US economic data, the Commerce Department said that personal income growth rose by 0.5 percent during April, but with the savings rate now up to a 14-year high of 5.7 percent, personal spending fell negative for the second straight month at a rate of -0.1 percent. A further breakdown of the report shows that rising wages certainly aren't the source of the growth in income. Instead, transfer payments, which include government benefits like social security, unemployment insurance, and disability, contributed the most registering a 2.3 percent increase. Meanwhile, the Institute for Supply Management's (ISM) index on manufacturing conditions rose more than expected to 42.8 in May from 40.1. While this is still below 50, signaling a further contraction in business activity, the moves suggest that the downturn in the sector is not accelerating. Furthermore, the new orders component rose above 50 for the first time since November 2007, suggesting that demand is finally starting to grow once again, while the price component surged to 43.5 from 32.0, helping to alleviate deflation concerns.

British Pound Dominates With Other FX Carry Trades as GBP/USD Tests 1.6500

The British pound appreciated versus nearly every other major currency, except the New Zealand dollar, helping to push GBP/USD up for a test of 1.6500. UK economic data was better than anticipated, as Markit Economics released their Purchasing Managers’ Index (PMI) for the UK manufacturing sector, which rose for the third straight month to 45.4 in May from 43.1. While the index remains below 50, signaling a further contraction in business activity, the steady improvements may signal broader improvements for the UK economy.

On Thursday, the Bank of England is expected to leave rates unchanged for the third straight month at an all-time low of 0.50 percent. Based on the BOE’s last policy statement and the minutes from the meeting, we know that the central bank expanded their quantitative easing (QE) program by 50 billion pounds to 125 billion pounds (which happened to be by a unanimous vote), that the drop in Q1 GDP of -1.9 percent was worse than expected, and that CPI will likely will be below the BOE’s 2 percent inflation target in the medium term. The minutes also revealed that some members thought that “a case could be made for a larger stimulus,” but the high uncertainty of QE led them to believe that there was “no pressing need for the larger extension” at that point. Ultimately, how the British pound responds will likely depend on the BOE’s QE stance. Signs that the BOE may increase their gilt purchases could weigh heavily on the British pound, especially against the euro, while the opposite (steady rates, no QE expansion) could provide a boost to the UK’s currency, though the markets are just as likely to show no reaction in this case.

Euro Backs Off From 1.4250, Ends Day Little Changed

Despite a rally early in the morning toward 1.4250, the euro ended the day almost unchanged against the US dollar. On Friday we saw that Euro-zone CPI data highlighted the contrast in interest rates between central banks like the Reserve Bank of Australian and the European Central Bank, as Eurostat estimates showed that CPI fell to an annualized pace of 0.0 percent, indicating a stagnation in price growth during the month of May. The drop from 0.6 percent was sharper than expected, and left inflation well below the ECB’s 2 percent target. Nevertheless, according to a Bloomberg News poll of economists, the ECB will leave rates unchanged at 1.00 percent next Thursday. Where the currency ends the day, though, may have more to do with what ECB President Jean-Claude Trichet says during his post-meeting press conference at 08:30 ET. Indeed, in May the ECB announced that they would buy 60 billion euros worth of covered bonds issued in the Euro-zone, but that details wouldn’t be released until after this upcoming meeting. As a result, much attention will be paid to which bonds will be bought and how the ECB plans on going about buying them, as direct buying from issuers would effectively supply them with direct funding, whereas the purchase of existing covered bonds would support prices and drive down yields.

Canadian Dollar Slips After GDP Falls by Most Since 1991, Australian Dollar to See RBA Rate Decision Overnight

The Canadian dollar ended the day mostly lower following Statistics Canada's release of Canadian GDP, which showed that the nation's recession deepened during Q1. Indeed, GDP fell an annualized 5.4 percent in Q1, the sharpest drop since 1991, following a 3.7 percent contraction in Q4 2008. That said, the decline was not as severe as expected but highlights the impact of the US recession on Canada, as exports tumbled. Domestic demand has waned as well as evidenced by the plunge in imports and a drop in consumer spending.

The Australian dollar, on the other hand, was quite strong due to solid demand for carry trades. Overnight, AUD/USD could respond to the RBA’s post meeting policy statement, even though they are anticipated to leave their cash rate target unchanged at 3.00 percent. After the central bank’s last meeting, RBA Governor Glenn Stevens said that future rate cuts would be based on “how economic and financial conditions unfold, and how they impinge on prospects for a sustainable recovery in economic activity.” As a result, it will be important to look to Stevens’ statement, as signs that the economy or financial markets are not holding up strongly enough for the RBA’s liking may suggest that the central bank will consider cutting the cash rate target again, and this news could weigh on the Australian dollar. On the other hand, indications of a broadly neutral bias and comments suggesting that 3.00 percent is essentially the floor for the cash rate target could support the currency.

Terri Belkas is a Currency Strategist at FXCM.