Dollar Stays Steady

The dollar stayed steady against both the euro and the yen at the start of week as traders remained cautious ahead of a crowded US economic calendar that may well determine Fed's monetary policy next week. In the aftermath of Friday's disappointingly weak US GDP report which printed at 2.5% versus 3.2% expected, fed funds futures plunged to 28% down from the near 80% certainty reached just two weeks ago.

Yet not everyone in the market is convinced that the Fed will pause at its August 8th FOMC meeting. Friday's GDP report also contained the largest increase in price level in 12 years and some market participants are convinced that the Fed may have to ratchet rates higher even at the risk of a slowdown to US the economy in order to remain credible in its combat of inflation.

As is so often the case the marquee event that will likely guide Fed policy and the direction of the dollar will come at the end of the week when the Non-Farm payroll figures for the month of July will be released. If the NFP's print north of 150K, the Fed will have far more flexibility to tighten as the employment numbers would signal that the US economy may have simply experienced a consolidation in growth rather than suggest that it is heading straight into a recession.

If however the employment numbers once again produce anemic results it will be game, set, match to dollar bears as the greenback's primary pillar of support (the ever rising yield of short term interest rates) will disappear.

In Japan today, the economic news was generally positive as both Manufacturing PMI and Industrial Production both reported above expectation registering readings of 55.7 and 1.9% against 54.3 and 1.3% respectively. In addition Japanese vehicle production jumped 7.4% from 3.2% the period prior.

The one slight blemish on tonight's economic report card was the lower than expected jump in Labor cash earnings which rose 0.5% vs. 0.6% expected. Nevertheless, overall the economic news from Japan continues to suggest that the recovery remains robust and that the pace of growth is likely to motivate the BOJ to hike rates at least once more before the year end. Furthermore, should the Fed indeed pause in August, the yen could strengthen even more, as the unit will no longer be viewed as an easy short for hedge fund carry trades - a strategy which has weighed heavily on the currency over the past 12 months.

In Euro-zone, German retail sales rebounded to 1.9% from the month prior on the back of World Cup demand. However, despite the massive infusion of tourism and marketing retail sales still declined -0.4% on a year over year basis indicating that the consumer in Euro-zone's largest economy remains reluctant to spend money.

The news should give pause to any euro bulls contemplating the idea of two 25 basis point rate hikes from the ECB in the month of August. Given the tepid recovery in consumer demand the ECB is likely to move quite slowly in its monetary tightening policy approach taking rates higher by only 25 basis points in August before reexamining the idea in September.