US Dollar, Japanese Yen Under Pressure as Risk Appetite Lifts Carry Trades, Equities

The US dollar continued its steady decline on Tuesday, while the Japanese yen ended on a mixed note, losing against the commodity dollars and euro while gaining against the US dollar, Swiss franc, and British pound. As usual, FX market price action was generally correlated to risk trends, as the S&P 500 and DJIA gained 0.2 percent. While the S&P 500 remains above its 200 SMA, the DJIA has stopped short of its own at 8751.25. Looking to the data on hand, the National Association of Realtors (NAR) reported that US pending home sales rose for the third straight month at a rate of 6.7 percent in April, signaling advancing sales of existing homes. The figures add to indications that recovery may be in the works for the housing sector, though far more substantial evidence needs to be seen before anyone can say that the housing fallout has truly bottomed.

On Wednesday morning, data may show that conditions in US non-manufacturing sector - which accounts for approximately 70 percent of total economic activity in the country and includes retail, services, and finance - improved somewhat in May as the Institute for Supply Management (ISM) index is estimated to rise to 45.0 from 43.7. Indeed, consumer confidence has shown emerging optimism, as the Conference Board’s measure has rocketed to 54.9 from 40.8 and the University of Michigan’s sentiment report rose to 68.7 from 65.1. Since risk trends have proven to be the greater driver of price action in the forex markets, a weaker than expected result could trigger flight-to-quality and thus, gains for the US dollar. On the other hand, evidence suggests we could see a surprisingly strong result, which could boost equities and weigh on safe-haven assets.

British Pound Rises Toward 1.66 as UK Data Points to Housing Recovery

The British pound may have rallied almost 1 percent against the US dollar, but the currency ultimately fell against most of the rest of the majors despite broadly better-than-expected UK data. The Bank of England’s measure of mortgage approvals rose more than anticipated to a one-year high of 43,201 in May while the Markit Economics Purchasing Managers’ Index (PMI) for the construction sector jumped to a 13-month high of 45.9 in May from 38.1. All told, the data adds to evidence of stabilization in the housing sector and also suggests that the Bank of England will leave rates unchanged on Thursday for the third straight month at an all-time low of 0.50 percent. Ultimately, how the British pound responds to the rate decision will likely depend on the BOE’s QE stance in their policy statement. 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.

Swiss Franc Down on Weak GDP, Euro Makes Headway Ahead of ECB Meeting

The Swiss franc was among the weak currencies on Tuesday amidst increased demand for carry trades, and as the State Secretariat for Economic Affairs said that Swiss Q1 GDP contracted for the third straight quarter at a rate of -0.8 percent from the previous quarter, the sharpest drop since Q2 1994. The decline came on the back of a 5.4 percent plunge in exports and a 0.4 percent drop in gross fixed capital spending. Even worse, the annual rate of growth fell 2.4 percent, the worst since the start of records in 1981. That said, consumption actually rose 0.1 percent, signaling that domestic demand is still holding up fairly well despite the global economic slowdown.

Meanwhile, the euro gained traction against most of the majors, as EUR/USD broke above 1.4250 and EUR/GBP tested former support at 0.8660. On Wednesday, Eurostat’s second release of Euro-zone GDP for Q1 shouldn’t be too market moving, as they are expected to confirm their initial estimates of a record 2.5 percent contraction from Q4, and a record 4.6 percent contraction a year earlier. However, with the European Central Bank scheduled to meet this week and announce their policy decision on Thursday morning, traders should watch out for a surprise revision, as this could impact sentiment amongst ECB policy officials. Indeed, a greater-than-expected decline in GDP would be bearish for the euro as the news would add to concerns that the Euro-zone nations haven’t done enough to revive their respective economies, and would put pressure on the central bank to take more aggressive action.

Australian Dollar Dominates Despite Dovish RBA Outlook, Though GDP Report Could Disappoint

The Australian dollar dominated on Tuesday, rallying more than 1 percent against the US dollar, despite the fact that the Reserve Bank of Australia (RBA) left rates unchanged at 3 percent, as expected, and left the door open to further rate cuts due to downside inflation risks. Tonight, though, the Australian Bureau of Statistics is projected to report that the Australian economy contracted again by 0.2 percent during Q1 from the previous quarter, while the annual rate of growth is forecasted to have fallen by 0.4 percent, the first decline since Q4 1991. The RBA noted this contraction in their recent policy statement, but also said that “considerable economic policy stimulus in train in most countries is helping to contain the downturn,” and saw the clearest evidence of a turnaround in China. Nevertheless, RBA Governor Glenn Stevens said that “the prospect of inflation declining over the medium term suggests that scope remains for some further easing of monetary policy,” and that the Board will “continue to monitor how economic and financial conditions unfold.” That said, growth numbers will be important to watch in coming months as a gauge of the RBA’s policy bias, and if the Q1 GDP results prove to be disappointing, the Australian dollar could fall on future rate cut expectations. On the other hand, signs of resilience in the Australian economy could add further strength to the currency.

Terri Belkas is a Currency Strategist at FXCM.