US Dollar Hits 5-Year High, Mortgage Rates See Biggest Jump in 3 Years: Problems Ahead?
With the stock market continuing to rise, it is not surprising that the US dollar hit a new five year high against the Japanese Yen today. In fact, the dollar is stronger across the board as inflationary pressures continue to manifest themselves. Producer prices increased 0.9 percent in the month of May while core prices increased 0.2 percent. This brought the annualized pace of inflation to the highest in 11 months. However it was not just past prices that had traders worried. Domestic supply concerns also drove oil prices to an 11 week high. This means that not only did inflationary pressures increase last month, but they are alive and kicking. This should keep Federal Reserve officials extremely hawkish, but don’t expect them to raise interest rates anytime soon because thirty year mortgage rates increased to 6.74 percent, the highest level since July 2006. The 21 basis point jump over the past week is the largest rise in 3 years. Thirty year mortgage rates have been skyrocketing since the middle of May and it is certainly not a coincidence that foreclosures hit record levels in the first quarter according to the Mortgage Bankers Association as well. More updated numbers from RealtyTrac Inc. also indicate that foreclosures are up another 90 percent last month. Federal Reserve President Moskow was spot on when he said that the spike in bond yields could trim growth because the housing market is exactly where the pain of higher yields will be felt. Although we expect the US economy to slow, a major contraction will probably be averted thanks to the offsetting stimulus that a weak dollar brings to the table. Consumer prices are on tap tomorrow along with the Empire State manufacturing survey, the current account balance, industrial production and the Treasury International Capital flow report. Given the rise in import prices and PPI, there is a strong chance that CPI will surprise to the upside as well. The rest of the data is also expected to be dollar positive.

Bank of Japan Not Expected to Raise Interest Rates, But Keep an Eye on USD/JPY Rate
Carry trades have continued to rise, but the moves today reflect cautious buying ahead of the Bank of Japan’s interest rate decision. Although the market does not expect the central bank to raise interest rates, there is a minor risk that they could. The Japanese Yen has sold off significantly over the past few months putting the government under pressure to put a halt to the currency’s slide. Now that the Yen has also hit a five year low against the US dollar, the criticism of the currency’s weakness could heat up. Prior to that, the Europeans were the primary ones complaining about the weak yen’s impact on global trade but the market barely reacted because their bark tends to be bigger than their bite. If the US starts getting uncomfortable as well, it becomes a totally different story. Therefore if USD/JPY continues to rise, the chance of a Bank of Japan interest rate hike will increase as well. In the meantime, continue to keep an eye on the US equity markets. Carry trades will die when the Dow dies. Aside from the BoJ interest rate decision, we also have the tertiary industry index and the BoJ monthly report due for release.

Is the Euro That Strong or Are People Not Interested in Trading It?
The Euro ended the day unchanged against the US dollar and this is either a testament to the currency’s resilience to dollar strength or the market’s falling interest in what is typically the most actively traded currency pair. According to the latest FXCM Speculative Sentiment index, it is the former since EUR/USD positioning is 8.7 percent above its monthly average. Given the weakness of recent economic data, the only things that are keeping the Euro propped are hawkish comments from ECB officials and continual demand from central banks. Both Eurozone consumer prices and labor costs fell short of expectations this morning which suggests that inflationary pressures are abating. However this doesn’t seem to matter to the ECB as member Quaden clearly stated today that monetary tightening has not ended. The same sentiment is shared by the Swiss National Bank who raised interest rates by 25bp today, bringing the mid point of their target range to 2.5 percent. If the pace of economic growth remains unchanged and the Swiss franc fails to rally, they said that “further increases in interest rates are likely in the months ahead.” Swiss retail sales are due for release tomorrow.

Softer Inflation Pressures Continue to Weigh on the British Pound
Despite stronger than expected retail sales in the month of May, the British pound refused to rally. This may be due to the fact that the price deflator dropped from April, which is an indication of softer inflation pressures. After the surprise decrease in average wage growth yesterday, the market has become very suspicious of whether the central bank really has the data to back up their hawkish monetary policy stance. A survey released today indicates that the British public expects prices to rise over the next year, but this is simply a reflection of consumer sentiment for prices rather than actual price increases by retailers.

Weak New Zealand Retail Sales Sends Commodity Currencies Tumbling
The Australian, New Zealand and Canadian dollars have all succumbed to dollar strength today despite firmer commodity prices. New Zealand retail sales were much weaker than expected in the month of April. After four straight months of gains, spending dropped by the biggest amount in 3 years. Vehicle sales, which are impacted by interest rate levels accounted for approximately 50 percent of the decline. Softer wage growth and consumer spending is certainly a problem and even though the RBNZ is still expected to raise interest rates this year, they may opt to wait until the third quarter. Meanwhile Australian consumer inflation expectations edged higher this month, but Australian Governor Stevens has a very different take. He actually feels that the inflation outlook gives the central bank time to assess economic data before making any changes to monetary policy. Weak data and a less hawkish stance have driven both currencies lower.

Kathy Lien is the Chief Currency Strategist at FXCM.