Euro strength may continue (page 1 of 2)

By Kathy Lien, Chief Strategist of DailyFX.com

Impact of Retail Sales on the US Dollar

The biggest event risk for the US dollar this week will be the April retail sales report.

Since hitting a record low against the Euro in the middle of last month, the greenback has strengthened significantly. However as the market finally latches onto the recent strength of the dollar, we are actually beginning to see a shift in its trend.

Since Thursday, the EUR/USD has already climbed over 250 pips from 1.5280 to 1.5530. The degree of consumer spending last month will play a major role in determining whether the recovery in the US dollar is over.

With Fed fund futures pricing in an 86% probability that interest rates will remain unchanged at the end of June, the market is convinced that the Federal Reserve will pause because they are shifting their focus away from growth and onto inflation.

Weak consumer spending is also very much discounted by the markets given the recent trend in the US economy, however exceptionally strong numbers on both a volume and value level would validate the central bank's decision to take a break from cutting interest rates and put us closer to the end of the Fed's easing cycle.

The US economy has been deteriorating, but a weak labor market does not always translate into weak consumer spending. In October 2001, when non-farm payrolls dropped $325,000, retail sales actually jumped 6.6%.

Retail sales can be very volatile on a month to month basis and even though non-farm payrolls dropped for four months in a row, US consumer confidence hit a 26 year low and house prices fell 12.7% in the month of February, there are signs that spending may not be exceptionally weak.

More specifically, the International Council of Shopping Centers reported a 3.6% increase in chain store sales while strong earnings have been reported by discounters such as Wal-Mart, Costco and Kohls.

According to Ken Perkins of Retail Metrics Inc, April was the best month for retailers since November. However traders may not care as much about the absolute change in retail sales than the underlying details of the report.

Gas prices have broken above $4 a gallon in many states and food prices are on the rise. Although this will boost the value of retail sales, but the volume of sales may be more important.

Euro Strength May Continue

The Euro has strengthened significantly against the US dollar after having hit an intraday low of 1.5280 on Thursday.

There was no Eurozone economic data released this morning, but hawkish comments from European Central Bank (ECB) President Jean-Claude Trichet continued to lead the euro higher.

After keeping interest rates on hold last week, Trichet reminded the market today that keeping inflation expectations firmly anchored and avoiding second-round effects is their top priority.

With no Eurozone economic data tomorrow, traders may continue to adjust their positions in reaction to the central bank's comments. Although we have been major euro bears for fundamental, technical and sentiment reasons, there is a good chance that the latest rally in the currency may continue.

The FXCM Speculative Sentiment Index flipped from net short to net long for the first since 2006 right when the EUR/USD was trading at 1.60. This morning, we reported in DailyFX plus that the FXCM SSI flipped back to net short. As a contrarian indicator, this in combination with Trichet's hawkish comments point to further gains in the euro.