Dollar: Beware Of Retail Sales

Dollar: Beware Of Retail Sales

It may have been a quiet day for the foreign-exchange market but that could change quickly with Tuesday’s U.S. retail sales report. Tuesday’s release has been extensively delayed, making the data stale in some ways, but consumer spending is the backbone of the U.S. economy and the latest report will show how weakly positioned the economy was before the government shutdown. Retail sales are expected to have stagnated in September after growing a measly 0.2% in August. Despite a significant decline in the unemployment rate, the third quarter was tough for the U.S. economy and conditions were only worsened by the problems in Washington. So while many investors have already adjusted their exposures for later tapering, weak data could still drive the dollar lower.

Monday morning’s U.S. economic reports were mixed with industrial production growth accelerating to 0.6% from 0.4% and manufacturing production growth slowing from 0.5% to 0.1%. Pending home sales also dropped 5.6%, which was the largest decline in three years and the fourth straight month of lower sales. While Monday’s economic reports may have been second tier, they paint the same picture of sluggish growth in the U.S. economy. The Federal Reserve is not expected to alter monetary policy or its forward guidance this week but if consumer spending slows alongside job growth, the central bank could downgrade its description of the economy, which would be enough to send the greenback to fresh lows. The last time that the Fed met, they said the housing market was strengthening and the labor market is showing further improvement but unfortunately both parts of the economy have deteriorated since then and their acknowledgement could solidify expectations for tapering in 2014 versus 2013.

In addition to retail sales and FOMC, a number of other important U.S. economic reports are also scheduled for release this week including Consumer Confidence, the ADP employment change, Chicago PMI and ISM manufacturing index. These reports will shed light on how weak the U.S. economy was going into the shutdown and how much damage Washington’s dysfunction had on the economy. Unfortunately we are looking for broad based disappointments with confidence hit by the government shutdown, spending slowed according to other similar reports released by the International Council of Shopping Centers and Johnson Redbook as well as softer manufacturing activity as seen in the NY and Philadelphia regions. This will make it difficult for the dollar to recover this week.

EUR: Consolidating At A Key Level

Like many major currencies, the euro consolidated against the U.S. dollar ahead of what should quickly become a busy week for the foreign exchange market. While the focus will be on the U.S., German unemployment and retail sales figures are also scheduled for release. What is interesting about the recent move in the EUR/USD is that the currency pair’s rally stalled right at the 61.8% Fibonacci retracement of the 14-month sell-off that lasted from May 2011 to July 2012 and took the pair from a high of 1.4940 to a low of 1.2040. A contraction in U.S. retail sales and/or surprisingly dovish comments from the Federal Reserve could be the trigger to drive the EUR/USD above its nearly two-year high of 1.3832. The strength of the euro comes from adjustments in expectations for Fed tapering and the desire to diversify out of U.S. dollars. This trend could gain momentum if this week’s U.S. economic reports are weak but the rise in the EUR/USD could be limited because the Fed is still expected to taper early next year and the ECB won’t be comfortable with a persistent rise in its currency for long. Last week, we said the central bank had previously expressed discomfort when the EUR/USD was trading at 1.36 and since the strength of the euro is due to dollar weakness this time around, which is out of their immediate control, their pain threshold should be above 1.40.

GBP: Signs Of Potential Weakness In Spending

The British pound traded lower against the U.S. dollar and euro on signs of weakness in consumer spending. According to the Confederation of British Industry, retail sales stagnated in the month of October. Economists had been looking for only a small pullback but the index dropped from a 15-month high of 34 down to 2. This means that 42% of the respondents reported that sales volumes increased while 39% reported a decline. The drop was caused primarily by weaker supermarket store sales but demand for food, drink and hardware also declined. This suggests that the more closely watched retail sales report could also show a retrenchment in spending this month. However retailers don’t seem to be are overly concerned about the deterioration. The CBI reports that “retailers expect sales to pick up next month and are upping orders with suppliers.” The housing market on the other hand remains stable with the Hometrack housing survey rising another 0.5% this month. Mortgage approvals, net consumer credit and lending are scheduled for release Tuesday and stronger numbers are expected all around.

AUD: Slips To 1-Week Low On Quiet Trading

With no economic reports released from Australia, New Zealand or Canada, it was a mixed day for commodity currencies. The New Zealand dollar rebounded after last week’s steep losses while the Australian dollar edged lower and the Canadian dollar consolidated. However don’t mistake consolidation with exasperation because traders are waiting patiently for this week’s big event risks. The commodity currencies will be particularly vulnerable because market-moving data will be released from both sides of the Pacific. The U.S. has retail sales and the FOMC meeting, which will be followed by the RBNZ rate decision and Chinese manufacturing PMI index. So far, data from China has been good with industrial profits rising 13.5% in the month of September, up from 12.8% in August. The AUD/USD dropped to a one week low but while the currency appears to be under pressure, the technical outlook could change quickly if U.S. retail sales contracted in September. The only piece of data expected from the three commodity-producing countries Tuesday will be Canadian industrial product and raw material prices. The numbers can be volatile and are generally not market-moving for the currency. Furthermore, inflationary pressures in Canada are muted, making the data even more inconsequential to the BoC. Instead, the AUD, NZD and CAD will trade based upon the market’s risk appetite and its reaction to U.S. data.

Yen Crosses Lifted By Japanese Equities

The Japanese Yen traded lower against all the major currencies Monday thanks to the rebound in equities. The Nikkei rose more than 2% overnight as Chinese SHIBOR rates declined off elevated levels. No Japanese data was released on Monday but markets were awaiting overall household spending, jobless rate, retail trade and small business confidence. Improvements are expected all around as easy monetary policy continues to lend support to the economy. The jobless rate is expected to decline and spending is expected to improve in the month of September. This should bode well for the Shoko Chukin index, which measures small business confidence. The most important event risks for Japan this week will be industrial production on Wednesday and the Bank of Japan rate decision on Thursday. The BoJ is expected to leave monetary policy unchanged but they will be releasing their semiannual outlook report that could include an upgrade to 2014 GDP forecasts.

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