US Dollar Mostly Lower as CPI Falls by Most Since 1950, Japanese Yen Gains Steam

The US dollar fell against most of the major currencies on Wednesday as the US Labor Department reported that their consumer price index (CPI) rose by only 0.1 percent in May, leaving the annual rate to plunge a whopping 1.3 percent, the sharpest drop since February 1950. However, a look at the core measure of the index, which excludes volatile food and energy costs, indicates that the year-over-year plunge was due primarily to commodity prices. Indeed, core CPI rose at an annual rate of 1.8 percent in May, down from 1.9 percent, suggesting that broader price growth is holding fairly steady and that deflation fears may not be warranted at this juncture.

Meanwhile, the Japanese yen was quite strong and made the most headway versus the British pound, US dollar, and Australian dollar. However, the yen ended the day virtually unchanged against the euro. The EURJPY pair in particular has been moving in lockstep with US equities, as both the DJIA and EURJPY fell in the morning, rose throughout the afternoon, and subsequently closed down just below key resistance at 8497.18 and 133.50, respectively. All told, risk appetite still remains on edge and has not been helped by the downgrades of the credit ratings of18 US bank downgrades by S&P, especially as five of them were pushed into junk territory. S&P cited the notion that "[o]perating conditions for the industry will become less favorable than they were in the past, characterized by greater volatility in financial markets during credit cycles and tighter regulatory supervision.” On the other hand, 10 banks returned $68 billion worth of TARP funds today, including JPMorgan Chase and Goldman Sachs, indicating that not all is equal in the banking sector at this juncture.

Ultimately, it’s undoubtedly positive that some of the nation’s biggest banks are returning taxpayer funds, but according to a press release published by the FDIC on May 27, their "Problem List" of troubled banks grew during the first quarter “from 252 to 305 institutions, and total assets of problem institutions increased from $159 billion to $220 billion.” As a result, it’s important to keep the situation in perspective, as there are still significant downside risks to the health of the financial sector and the economy at large.

Euro and Swiss Franc Moving in Tandem Ahead of SNB Policy Decision - Watch for Talk of Intervention

EUR/CHF ended the day virtually unchanged on Wednesday, but this has essentially been the case over the past few months following the Swiss National Bank’s March 12 intervention announcement. The pair’s ultra-tight range since then suggests that they have indeed been trying to hold the Swiss franc back, and 1.5000 may be their proverbial “line in the sand.” However, the SNB’s devotion to this cause will be tested on Thursday at 3:30 ET as their latest policy decision is due to hit the wires. The SNB is expected to leave their 3-month LIBOR target range unchanged at 0.0 percent – 0.75 percent, but the thing to watch for in the SNB’s subsequent policy statement is talk of FX intervention. Indeed, if we see a repeat of the SNB’s line that they want to “prevent any further appreciation of the Swiss franc against the euro” in an effort to “counter the risk of deflation and of a dramatic deterioration in the economy,” the Swiss franc could plunge once again, especially against the euro. On the other hand, signs that they are giving up on intervention could send EUR/CHF plunging below 1.5000.

British Pound the Weakest of the Majors Despite Better Than Expected Data, BOE Minutes

The British pound fell sharply on Wednesday even though the UK's Office for National Statistics reported that the number of claims for jobless benefits rose less than expected by 39,300 to 1.54 million in May, pushing the claimant count rate up to 4.8 percent from a downwardly revised 4.6 percent. This was the smallest increase in claims since July 2008, indicating that the pace of job losses is starting to slow. Meanwhile, the minutes from the Bank of England's last policy meeting showed that all nine members of the Monetary Policy Committee (MPC) voted in favor of continuing their quantitative easing program. The MPC sounded cautiously optimistic, saying that risks for a "continued sharp contraction in output in the near term had receded somewhat," but that "there was no reason to conclude that the medium-term outlook for the economy, and thus inflation, had changed materially." However, BOE Governor Mervyn King took a slightly more pessimistic tone during a speech today, as he said that additional equity capital may be needed “before the banking system will be able to supply credit at a price and on a scale to finance a sustained recovery,” and “it is too soon to reverse the extraordinary policy stimulus that has been injected into the UK economy through monetary policy.”

Canadian Dollar Mixed Ahead of Thursday’s Key CPI Release

The Canadian dollar was broadly mixed versus the majors, gaining against the British pound, US dollar, and Australian dollar but lost against the New Zealand dollar, Japanese yen, euro, and Swiss franc. Canadian data was weak as Statistics Canada said that wholesale sales fell by 0.6 percent in April, marking the seventh straight month of contraction. Adding to this, inventories plunged 1.3 percent during the same period, suggesting that businesses do not foresee demand picking up anytime soon. The data doesn't bode well for Friday's release of Canadian retail sales, which are currently expected to have risen a slight 0.1 percent in April but may ultimately disappoint.

On Thursday, some key Canadian data will be released. According to the Bank of Canada’s last Monetary Policy Report in April, the Bank is open to quantitative easing (QE) and credit easing if nominal interest rates start to fall below zero. Indeed, the Bank stated that while they could cut rates to zero in theory, it would ultimately "eliminate the incentive for lenders and borrowers to transact in markets, especially in the repo market." As a result, inflation reports will be key to gauging whether the Bank of Canada will go the route of QE. Headline CPI is projected to have risen 0.4 percent in May, leading the annual rate to fall negative for the first time since November 1994 at a rate of -0.2 percent. Meanwhile, core CPI is forecasted to have risen 0.1 percent during the month, leaving the annual rate down at 1.6 percent from 1.8 percent. All told, the Canadian dollar may only respond if CPI rises more than expected (CAD bullish), or if CPI contracts on a monthly bases and drags the annual rates of price growth much lower (CAD bearish).

Terri Belkas is a Currency Strategist at FXCM.