US Dollar Down Over 1%, Japanese Yen Mixed as 10 US Banks Say They Will Repay TARP Funds

The US dollar experienced sharp retracements on Tuesday, falling more than 1 percent against majors ranging from the Canadian dollar to the British pound. Meanwhile, the Japanese yen ended on a mixed note as many of the yen crosses consolidated below their recent highs, which is exactly what we’ve seen in the equity markets. Indeed, the DJIA was unable to break above resistance at 8800 and closed down 1.4 points at 8763.06 while the S&P 500 tested yesterday’s high of 946, but backed off and closed up 3.3 points at 842.43. Looking to the economic data of the day, the US Commerce Department said that wholesale inventories tumbled for the eighth consecutive month in April at a rate of -1.4 percent as businesses anticipate further declines in demand. In fact, sales fell a slight 0.4 percent during the same period, and the reduction in supplies helped bring the inventory/sales ratio down to 1.31 from 1.32. That said, this report is quite lagging, and as a result, wasn't very market-moving.

Instead, news that ten US banks, including Goldman, Morgan Stanley, JPMorgan, American Express, Northern Trust, BB&T, State Street, US Bancorp, Capital One Financial and Bank of New York Mellon, would repay TARP funds totaling $68 billion helped to lift risk appetite. Treasury Secretary Timothy Geithner noted that repayment was an "encouraging sign of financial repair," and the rise in equities suggested that traders believed the same.

On Wednesday, the Federal Reserve’s Beige Book report will be released and is likely to reflect much of the same thing we’ve seen in recent months: weak consumption, slow manufacturing conditions, a depressed housing market, deteriorating labor markets, and downward price pressures. That said, any hints of optimism or “green shoots” could offer a boost to investor sentiment, while a repeat of past reports should impact FX trade too much.

Euro Rebounds Against the Greenback Despite Dismal German Trade Results

The euro surged just over 1 percent against the US dollar on Tuesday, but this was due primarily to broad weakness in the greenback. Indeed, the euro was mixed against the rest of the majors, as it fell against the British pound and Australian dollar and gained versus the Canadian dollar, New Zealand dollar, and Japanese yen. German economic data was generally weaker than expected, as the Federal Statistics Office said that the German trade surplus narrowed to 9.4 billion euros in April from 11.3 billion euros as exports plunged 4.8 percent. That said, imports fell by the most in five months at a rate of -5.8 percent, indicating that domestic demand is actually falling faster than foreign demand. This dynamic has taken a hefty toll on industrial production, as the Economic Ministry said that output surprisingly fell 1.9 percent in April, dragging the annual rate down to a new record low of -21.6 percent. Ultimately, the combination of weakening demand and output doesn't bode well for growth in Q2, as data is likely to eventually show that GDP contracted for the fourth straight quarter.

British Pound the Strongest of the Majors as UK House Price Declines Slow

The British pound was once again the strongest of the majors, gaining over 1.5 percent against the US dollar, as the UK’s Department for Communities and Local Government (DCLG) said that house prices were down 13 percent in April from a year earlier, up from -13.6 percent in March. This was the first time since October 2007 that the index did not reflect an accelerated drop in prices, suggesting the UK’s housing market collapse may be nearing a bottom. Meanwhile, Bank of England (BOE) Monetary Policy Committee (MPC) member Paul Tucker said during a speech that despite some improvement in near-term indicators, the medium-term outlook was “highly uncertain” as it was not year clear “whether the financial system can generate the expansion of credit that will most likely be necessary to support recovery.” On quantitative easing, Tucker said that the “mildly upward sloping money market curve, which signals that the market is confident – as it should be – that the MPC will retighten monetary conditions when in due course that is warranted by the medium term outlook for inflation.” All told, Tucker’s comments signal cautious optimism, which may be the general sentiment amongst the MPC members as a whole.

New Zealand Dollar Due to Face RBNZ Rate Decision on Wednesday

On Wednesday at 17:00 ET, the Reserve Bank of New Zealand (RBNZ) is anticipated to announce that they will leave the Official Cash Rate target unchanged at 2.50 percent for the first time since June 2008. In April, the RBNZ cut their official cash rate target last night by 50 basis points, as the "world economy deteriorated more than expected" during Q1. Looking to the RBNZ Governor Alan Bollard’s policy statement, it is clear that the central bank has cut back their inflation expectations due to weaker global growth and tight financial conditions. Furthermore, the RBNZ anticipated that the “adverse economic forces generated by the crisis to remain dominant throughout 2009,” with the “timing and extent of recovery” remaining “highly uncertain.” Adding to this bearish sentiment, the RBNZ expected to leave the OCR at or below current levels through the end of 2010, which weighed heavily on the New Zealand dollar at the time. A reiteration of this bias should do the same this time around, but if the central bank strikes a more neutral tone, the New Zealand dollar could actually rally.

Terri Belkas is a Currency Strategist at FXCM.