Markets Feel Good as Uptrend Returns in Dow, Bond Yields and US Dollar
The snapback in the Dow Jones Industrial Average today was nothing short of impressive. Having been down over 100 points yesterday, the Dow slid another 86 points at the onset of US trading. Fortunes were reversed however as the Dow rebounded just as quickly as it fell. Yields suffered the same fate as they sold off sharply ahead of the US equity market open but rebounded shortly afterwards. The US dollar was the only asset that refused to fall. In fact, the biggest loss that we saw in the US Dollar against the Japanese Yen over the past 24 hours was a modest 20 point drop. The Euro on the other hand remained trapped within a 30 point trading range throughout the day. Although the rise in bond yields as well as the jump in the Philadelphia Fed index could be credited for taking the dollar and the Dow higher, the market’s feel-good factor is primarily keeping risk appetite high. The US economy faces problems from the fallout of the Bear Sterns hedge funds, but with no new bailouts surfacing the market is hoping that this is an isolated incident. Whether or not this is true remains to be seen. Like the Empire State manufacturing survey, the Philly Fed index jumped to a 2 year high in the month of June. The rise was driven almost exclusively by an increase in new orders since both the employment and prices paid components dropped. Underlying weakness capped any major movements in the dollar despite the magnitude of the surprise. Trading should continue to remain quiet over the next 24 hours with no US data due for release. This type of market has been perfect for range traders.

USD/JPY Hits New 4-Year High
Unsurprisingly the fact that the Dow failed to slide for another day has led to a rebound in carry trades. Yen weakness remains the predominant theme in the markets which indicates that risk seeking appetite remains high. In fact, the appetite is so strong that USD/JPY hit a fresh 4 year high today while AUD/JPY reached a new 15 year high. Part of the weakness in the Yen can be attributed to the smaller than expected trade surplus in the month of May. Even though the Yen was weak, the drop in the US dollar reduced the country’s demand for Japanese exports. Each piece of disappointing economic data only further postpones the Bank of Japan’s next interest rate hike. Like the US, there is no economic data from Japan until next week, when the Japanese economic calendar picks up significantly. Therefore carry trades will continue to be at whim of the US equity markets. Do not underestimate the power of the carry; it will only die when the rally in the Dow comes to an end.

Euro: Becoming the Perfect Currency for Range Traders
Range traders should be having a ball with the Euro as the currency pair oscillates within a 30 pip range throughout the US session. Range trading has been fueled by mixed economic data that gives little insight into when the European Central Bank may raise interest rates next. Both the PMI manufacturing and service reports accelerated in the month of June, but French and Italian consumer spending both took a nosedive last month. All three of the main Eurozone nations have now reported a deceleration in consumer spending which is not good for the region’s overall economic outlook. The PMI reports are conflicting and confusing which makes it difficult to tell which direction the German IFO report will sway tomorrow. The market is currently looking for business sentiment to remain unchanged at 108.6. With the dip in the German ZEW index earlier this month, the odds are slightly skewed to the downside. Meanwhile over in the Switzerland, the trade surplus increased last month thanks to the weakness of the Swiss franc. The currency’s refusal to rise will continue to provide stimulus for the overall economy.

Stronger Economic Data Keeps British Pound Steady Against the Dollar
Among the majors, the British Pound held up the best against the US dollar thanks to continued optimism about further interest rate hikes and stronger economic data. CBI industrial orders accelerated in the month of June, indicating that the strength of the British pound is not holding back overall demand. This of course supports the potential for 6 percent interest rates by the end of the year which explains why the British pound has outperformed the Euro for the last 4 trading days. Bank of England Governor King also confirmed the central bank’s intentions to tackle inflation aggressively. He indicated that the MPC is determined to bring inflation back to target. As we all know, the MPC’s primary tool to achieve that is the lending rate. Although the GBP/USD is stalling, another stab at 2.0 is very likely. There is no economic data due for release tomorrow.

New Zealand Dollar Trading Back Near Pre-Intervention Levels
It seems that fading intervention is the market’s best bet as the initiatives taken by the Reserve Bank of New Zealand has done little to stem the currency’s rise. In fact the New Zealand dollar is now trading back near pre-intervention levels. The central bank is certainly not going to be happy about this, which raises the possibility of further intervention. However, be forewarned as the RBNZ’s intervention war chest remains very small. The Australian dollar is higher as well, which indicates that the market’s demand for the high yield currencies is robust. The Canadian dollar on the hand sold off significantly. Retail sales increased a paltry 0.4 percent in the month of April. Excluding automobiles, sales were flat that month. This puts an end to the strong trend of consumer spending that we have seen over the past few months as well as the downtrend in USD/CAD, at least for the time being. Even though high energy prices, poor weather, and an early Easter are all to blame, the bottom line is that we are beginning to see serious holes or weakness in the Canadian economic growth story.

Kathy Lien is the Chief Currency Strategist at FXCM.