Why USD Shrugged Off Retail Sales

The U.S. dollar should be trading higher against all of the major currencies this morning after better than expected retail sales numbers. We know that bond traders are happy with the release because ten year Treasury yields rose to a one week high and the S&P 500 opened in positive territory but initial gains in USD/JPY were given up as the currency pair struggles around the key 100 level. The dollar's performance in general is very fractured today with the greenback trading higher against the euro and commodity currencies but lower against the British pound and Japanese Yen.

What If?
Despite the U.S. government shutdown, October has turned out to be a good month for the U.S. economy and this leads us to wonder how much stronger the recovery would have been if the U.S. government remained opened throughout this time. Between the sharp rise in non-farm payrolls, the increase in retail sales and the expectations for a snapback in November, not only is GDP growth expected to accelerate in the fourth quarter but if they wanted to, the Fed could justify reducing asset purchases at the end of the year.

According to last night's comments from Bernanke, the Federal Reserve wants the market to distinguish between tapering and tightening before making a move. Back in September, they refrained from tapering because U.S. 10 year Treasury yields were above 2.85% but with yields currently at 2.7%, he feels the market is now better at differentiating between the two. Bernanke is telling us without any ambiguity that the decision to taper next month hinges largely on where U.S. rates are at the time. If 10-year yields are above 2.85%, the Fed will stand down. If rate are 2.7% or lower, pre Christmas tapering remains on the table.

Strong Consumer Spending
U.S. retail sales rose 0.4% in the month of October, the strongest pace of growth in 3 months and excluding auto and gas purchases, retail sales rose a more than expected 0.3%. Not only where there broad based gains in spending but the September figures were also revised up from -0.1% to 0.0%. However with consumer prices dropping 0.1% last month and existing home sales dropping to a 4-month low, the Fed could also leave monetary policy unchanged because as Janet Yellen indicated, price pressures are nonexistent.

The FOMC minutes are scheduled for release later this afternoon and its tone could affect how the dollar trades. When the FOMC statement was released, the dollar soared because the central bank sounded open to the idea of tapering asset purchases in December. The Fed was not overly concerned about the sluggish pace of job growth in September and even said labor market conditions have improved. Since then, this optimism has been verified by the latest payrolls reports. The central bank is also no longer worried about tighter financial conditions or higher mortgage rates that could have slowed the recovery. They wanted to continue to monitor incoming data to determine when it would be appropriate to adjust the level of asset purchases. The statement was less dovish than investors had anticipated and if the minutes are the same, it could renew the rally in the greenback.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.