US Dollar Gains as Treasury Yields - US Retail Sales Could Disappoint on Thursday

The US dollar was generally strong on Wednesday, though the currency did fall against the Australian dollar and British pound, as Treasury prices plunged, sending yields higher. In fact, the yield on 10-year notes hit an intraday high of 3.99 percent, the highest since October 2008 after Bank of Russia first deputy chairman Alexei Ulyukayev said that they would switch some of their reserves from Treasuries to International Monetary Fund bonds. The comments echo those of China, which has said that it is “actively” considering buying as much as $50 billion of the IMF bonds, while Brazil’s Finance Minister Guido Mantega said that they will purchase $10 billion worth of IMF bonds. Meanwhile, the Commerce Department said that the US trade deficit widened for the second straight month in April to $29.2 billion, while the Federal Reserve’s Beige Book report showed that the twelve Federal Reserve District Banks saw that economic conditions “remained weak” or “deteriorated further” between mid-April and May. However, five of the Districts also said that the “downward trend is showing signs of moderating,” adding to indications that the worst has passed for the US economy.

Looking ahead to Thursday, the Commerce Department is forecasted to report that US retail sales rose 0.5 percent in May after tumbling 0.4 percent in April, and excluding autos, retail sales are anticipated to increase by 0.2 percent. However, there is potential for a worse-than-expected result, as the latest ICSC chain store sales numbers show that consumption plunged by 4.6 percent in May from a year ago. The response of the US dollar to the results will be interesting as the currency finally responded to fundamental forces following the release of US non-farm payrolls for the month of May. Prior to that, risk trends had been the predominant driver of price action for the greenback, so this round of advance retail sales may serve as a good gauge of how strong risk links are in the FX market.

Euro, British Pound on Opposite Sides of the Spectrum as UK Industrial Production Rises

The euro was extremely weak on Wednesday, losing against nearly every major currency, but on the other hand, the British pound dominated. There wasn’t much in the way of European economic news, but according to the UK's Office for National Statistics (ONS), the nation's visible trade deficit widened to 7.003 billion pounds from 6.471 billion pounds during the month of April, as import growth outpaced a pickup in exports. At the same time, the ONS also said that industrial output rose by 0.3 percent during April, the first increase since February 2008 and the largest rise since October 2007. The improvement was due primarily to jump in mining and quarrying production, though the 0.2 percent increase in manufacturing output was notable in that it was the second consecutive positive result. That said, it's important to keep these moves in perspective, as the annual rate of industrial production remains deeply negative at -12.3 percent.

Japanese Yen Tumbles Ahead of Final Q1 Japanese GDP Reading

The Japanese yen was the weakest of the majors on Wednesday, tumbling more than 1 percent against the ultra-strong Australian dollar and British pound and falling 0.77 percent versus the US dollar. Most of the losses came during the Asian trading session though, as losses in the US equity markets subsequently pushed the Japanese yen higher. Tonight at 19:50 ET, Japan's Cabinet Office will release their final growth readings, which should confirm that the economy contracted for the fourth straight quarter in Q1 2009. However, this reading is anticipated to be revised higher once again, this time to -14.9 percent from -15.2 percent. While this would still be the worst result on record, the revision has potential to provide a boost to the Japanese yen, which is what we saw with the release of the preliminary reading on May 19. On the other hand, a revision to the downside could weigh heavily on the low-yielding currency.

New Zealand Dollar Jumps on RBNZ Rate Decision, Australian Dollar Faces Employment Data Overnight

The Reserve Bank of New Zealand (RBNZ) left their Official Cash Rate target unchanged at 2.50 percent, as expected, citing evidence that "international economic activity is stabilizing and international financial conditions are improving." RBNZ Governor Alan Bollard was somewhat optimistic in his post-meeting policy statement, saying that "for the first time in some months," there were "clear upside opportunities for activity." However, these comments were generally the sole confident notes as Bollard also noted downside risks to activity and inflation, with the appreciation of the New Zealand dollar creating an "unhelpful tension" with their projections. That said, Bollard wrote off the need to intervene in the FX markets, saying that neither intervention nor a rate cut would impact the currency. Going forward, the RBNZ has left the door open to "modest" reductions "in coming quarters" as they reiterated their previous statement that they "expect to keep the OCR at or below the current level through until the latter part of 2010." Keeping this in mind, the New Zealand dollar's initial rally in response to this policy decision could ultimately prove to be short-lived.

The Australian dollar gained on Wednesday, especially against the low-yielding Japanese yen, but the currency faces event risk overnight. The Australian labor markets started to deteriorate during the second half of 2008, and data may show that this is continuing through 2009. While we did see a surprise improvement in April, the May results are projected to show that the unemployment rate rose back up to 5.7 percent from 5.4 percent while the net employment change is anticipated to fall by 30,000. The latter report tends to have a greater impact on the Aussie since the figure rarely meets expectations and can lead to volatile short-term price action for the Australian dollar immediately following the news at 21:30 EDT.

Terri Belkas is a Currency Strategist at FXCM.