Carry Versus Growth Will be the US Dollar's Next Battle, British Pound Continues to Soar on Strong Data, Japanese Yen Firms Ahead of BoJ Monthly Report
US Dollar – The market has been very quiet today but traders should not lose sight of the fact that last week marked a major turning point for the US dollar. After slowly strengthening since the month of August, the uninteresting changes that the Fed made to their FOMC statement last Wednesday led to extremely interesting price action in the currency market. The US dollar saw its longest stretch of weakness since July and for the most part, the weakness continued into the new week.
Although the greenback rebounded against the Euro and Canadian dollar, it extended its sell-off against the rest of the majors. This morning's US data was hardly helpful as weaker growth in spending was offset by stronger growth in income. The problem is that economic growth is at risk while the inflation outlook is unclear. Even though core consumer prices increased strongly in the month September, core PCE and the price index in the third quarter GDP report fell short of expectations.
Even today's annualized PCE deflator increased less than expected despite a revision to last month's core PCE month over month number. The Federal Reserve is on hold at the moment and not likely to move until next year at the earliest. This means that going forward, it will be a matter of carry versus growth. The US' 5.25 percent interest rates are still very attractive, which could bring carry trades back into style, but if US data indicates that growth is taking a major turn for the worse, the market's projections for a rate hike may become too much for the US dollar to handle.
Meanwhile despite today's quiet price action, this is a big week in the currency market with the G7 countries releasing a tremendous amount of data. In the US tomorrow, we are expecting consumer confidence along with the Chicago PMI report. Given the weakness in industrial production, Philly Fed and ISM, the Chicago PMI report is expected to drop and even if it manages to rise, the strength will probably be shrugged off as other data suggests weakness in the manufacturing sector nationwide. The Conference board's consumer confidence reading however is predicted to be strong after last Friday's rise in the UMich consumer confidence survey.
Euro and Swiss Franc – In contrast to its global counterparts, the Euro did not manage to extend its strength against the US dollar. Economic data was decent with the French business survey rising 4 points to 17 and unemployment dropping by 20k, bringing the jobless rate down from 9.0 percent to 8.9 percent. The weakness in the EUR/USD can be mostly attributed to earlier EUR/JPY selling.
The 150 level has proven to be staunch resistance in the pair and traders have been adamant about keeping it below that level. There is a ton of Eurozone economic data due for release tomorrow with German retail sales as the highlight. After stagnant consumer demand in August, a revival is expected for the month of September.
The Eurozone economy is doing well for the most part, which will keep the central bank on track to raise interest rates. There has been no news out of Switzerland. However, for those who listened to the Swiss Finance Minister's comments last week about the Franc needing to strengthen against the Euro, awards were doled out in the form of profits. EUR/CHF fell for three consecutive days which was its longest stretch of weakness since mid September. There is no data due for release from Switzerland until Wednesday.
British Pound – The British pound easily took out the 1.90 level against the US dollar to register gains for the fourth consecutive trading day. Economic data continues to print strongly which is fueling the recent strength in the currency pair. Housing market indicators such as consumer credit and mortgage approvals highlighted further growth in the sector while faster money supply growth indicated inflationary pressures.
Collectively, this suggests that the Bank of England will soon be delivering another interest rate hike, which is actually quite possible given last week's hawkish comments from BoE officials. The central bank will be meeting next week and the odds are already in favor of bringing rates up from 4.75 percent to 5 percent. Even though there are a number of economic releases scheduled between now and then, none are expected to shift the outlook.
Japanese Yen – The Japanese Yen is firmer today against the US dollar and Euro thanks to a smaller than expected drop in industrial production in the month September. Although a drop in IP is certainly nothing to write home about, the underlying rebound in exports is encouraging. We continue to believe that the weak Yen will have broad sweeping benefits for the country and the economic data is beginning to show that. In fact, traders are closely anticipating this evening's monthly report from the Bank of Japan.
Even though interest rates are not expected to be changed, the central bank could express more optimism about economic activity and inflation which would be very positive for the currency. In addition to that, unemployment, personal income, PMI, PCE, housing and construction starts are also due for release. The market is also looking for improvements in all of the reports.
Commodity Currencies (CAD, AUD, NZD) – Oil prices are back below $60 a barrel and that has hit the Canadian dollar along with a larger than expected drop in raw material and industrial product prices. For a country that is heavily dependent on oil exports, the drop in price of their most valuable commodity will eventually hit the economy as well. It is only a matter of time. New Zealand data also helped the currency rebound with building permits hitting an 18 month high and business confidence improving. Even though Australia did not have any economic data released, the combination of a rise in gold prices and the prospect of another rate hike by the central bank have the market bidding up the currency.
This morning's Sydney Morning Herald had an article suggesting that the Australian government would be very unhappy if the Reserve Bank of Australia did not raise interest rates. The recent improvements in Australian economic data support the latest strength in the currency.