Dollar Consolidates Gains

The foreign exchange market, and the capital markets more generally, are subdued after several days of dramatic moves.  The attempt to extend yesterday's dollar gains in Asia was limited and seemed to bring in some profit-taking ahead of the weekend.   

The North American session will begin with the major foreign currencies near the highs for the European session.  There may be a bit more upside, but North American players have seemed more bearish the foreign currencies this week and it would not be surprising to see them make another run at the lows.  Yet without fresh incentives or news developments, look for a largely range bound session.

The news steam following the Moody's well-tipped downgrades has been light.  The most important may have been the German IFO survey.  The business climate measure fell to 105.3 from 106.9, a new two-year low.   The improvement in the current assessment was offset by the deterioration in expectations.   

Now that another round of stress tests has been completed, Spain is expected to formally request funds later today or perhaps early next week.  A memorandum of understanding is necessary to lay out the size of the program and conditions and that might take a couple of weeks.  

With the Fed extending Operation Twist and high expectation that the BOE resumes buying gilts next month, the attention is returning to the ECB.   There seems to be increased likelihood of a rate cut.  There is even some talk of a 50 bp cut in the repo rate and a 25 bp cut (to zero) of the deposit rate (which is really understood as the floor of rates (but yes the German two year, for example, has traded through the deposit rate).  

There are also reports suggests that the ECB could announce more liberalization of collateral rules, though it is likely meeting resistance by a number of creditor countries.  The use of liberal collateral rules is one of the under-appreciated measures by the ECB that have provided support for the European financial system.  The broader collateral rules may in  particular, benefit Spanish banks.

The dollar's three-day bounce against the yen has carried it up 2.25% to JPY80.50.  The JPY 80.15 area corresponds to a retracement objective of the dollar's slide since March 15 high  just above JPY84.00.  The next retracement objective comes in just below JPY81.  The main driver seems be some widening of 2-year interest rate differentials, but there also seems to be some participants focusing on the likelihood that the retail sales tax is hiked, as Prime Minister Noda has been pushing for.  Support for the dollar is now seen at former resistance near JPY80.  Today could be the first day since May 16 that the greenback holds above JPY80 for the entire 24-hour session.

Lastly, Canada reports consumer price inflation.  The risk is on the downside of the consensus 0.1% increase.   Yesterday's retail sales report was poor, falling 0.5%, compared with a 0.2% expectation.  It fully offset the 0.4% increase in March.  The Bank of Canada's Carney still was touting a hawkish line yesterday, but his concern about the housing market seems to be being addressed through broader regulation (macro-prudential) than interest rates.  

In fact a soft CPI figure may help encourage a further unwinding of interest rate expectations.  With the Fed on hold for at least the better part of two years, it is hard to imagine, based on current data and trends, for the BoC to raise rates so far ahead of the US.  The CAD1.03 level may be a near-term cap, but support for the greenback is likely seen near CAD1.0240 near-term.