Carry Trades Come Close to Erasing Tuesday Losses (page 1 of 2)

Will Retail Sales Be Strong Enough to Trigger a Turn in the US Dollar?

Even though the US dollar has seen some big moves over the past two trading days, the volatility was not triggered by a shift in the market's attitude towards the dollar but instead by the sharp swings in the US equity markets and carry trades. This dynamic will change when we receive the reports on US retail sales and producer prices tomorrow. Normally these numbers can single handedly make or break it for the US dollar but unfortunately traders these days have become very skeptical. The forecasts for retail sales are low which means that even if they come out better than expected the market will question whether a strong pace of spending is sustainable. With non-farm payrolls holding steady over the past few months, consumer spending may be less affected by higher food and energy costs. Also, gas prices did not tick higher until November which means that there is a stronger case for dollar positive numbers. Pending home sales today was good as well, rising by 0.2 percent instead of dropping 2.5 percent like the market expected. As for inflation, analysts are expecting a tepid rise on month to month basis, but on an annualized basis, inflation growth is expected to hit a 2 year high. The combination of a weaker dollar and rising food and energy prices should lead to stronger inflation. Whether that will have a lasting impact on the US dollar however remains to be seen. When Bernanke gave his testimony to the Joint Economic Committee last week he focused more heavily on the downside risks to growth than the upside risk to inflation. Tomorrow's numbers will tell us whether Bernanke's balance of risk assessment was right.

Carry Trades Come Close to Erasing Tuesday Losses
The Dow is up 320 points and the Chicago Board Options Exchange Volatility Index (VIX) is down 7, paving the way for a sharp rebound in carry trades. There was no real news to drive the price action other than stronger than expected earnings by Wal-Mart and a 3 percent drop in oil prices. Although it may be tempting to believe that the downtrend in carry trades is over, with the exception of USDJPY, none of the Japanese yen crosses managed to close the US trading session above yesterday's highs. This is not to say that the rebound will not continue but the lack of any real news to support the move makes it questionable. The Bank of Japan left interest rates unchanged last night at 0.5 percent, which was right in line with expectations. GDP growth was also stronger than expected thanks to a rise in exports. Part of the Yen's weakness today was blamed on the comments from Prime Minister Fukuda who warned against a rapid rise in the Yen, but he also indicated that he had no problems with long term appreciation in the currency. It appears that 110 is the line in the sand for the Japanese government and if we break that again we could hear more serious calls for intervention.

Euro Unfazed By Sharp Fall in Analyst Sentiment
The German ZEW survey of analyst sentiment fell to the lowest level in 15 years but that did not prevent the Euro from rebounding against the US dollar today. Analysts have been notoriously more pessimistic about the outlook for the Eurozone than businesses and over the past few months they have been proved wrong more often than right. The German economy has been far more resilient in the face of Euro strength than most people could have anticipated and it is for this reason that the ECB stands ready to raise interest rates.