USD Keeps Pressure On Major Currencies

Demand for U.S. dollars kept pressure on the euro and all major currencies throughout the North American session. Between the recovery in U.S. stocks and the surge in U.S. yields, the dollar is one of the most coveted currencies. Even though we haven't seen a major pickup in foreign demand for U.S. dollars, particularly from Japan, the longer U.S. yields hold above 2% (10 year yields are at 2.15%), the more tempting it will be for foreign investors. The lack of U.S. data at the front of the week means the lack of threat to the dollar rally. As long as the good news continues to flow in, the dollar will remain in demand. How well the greenback performs against various currencies will of course depend on how economic data from those countries fare. We have seen some recent improvements in euro-zone data that reduces the chance of additional easing by the European Central Bank. German labor market numbers are scheduled for release Wednesday and an upside surprise will keep the EUR above 1.28. The main driver of EUR/USD weakness has been the divergence between U.S. and euro-zone data -- one was improving as the other was deteriorating. If we start to see improvements in the euro-zone economy, then the dynamics affecting the euro will start to change to benefit of the currency. Unfortunately based on the latest PMI numbers, there's a risk of a downside surprise. According to the report, staffing levels fell for the first time since January with job shedding seen in both the manufacturing and service sectors. If unemployment rolls climb in the month of May, the EUR/USD could extend its losses but even then, the losses could be contained to 1.28, a level that has held for the past month. We probably need to see back to back weakness in euro-zone data (German unemployment and retail sales) for 1.28 to be broken.

Dollar: Another Round Of Good Data
The U.S. dollar traded higher against all of the major currencies Tuesday with the exception of the AUD and NZD, which held steady after falling dramatically over the past month. The 13bp rise increase in 10-year yields has taken it to a fresh one-year high and as long as yields continue to rise, we will expect USD/JPY to make new highs. At a time when the rest of the world economies are on shaky ground, U.S. economic data continues to surprise to the upside, making the dollar extremely attractive to global investors. Consumer confidence surged to its highest level in five years. Thanks to the improvement in the labor market and the persistent rise in stocks, the Conference Board's measure of consumer sentiment rose to 76.2 in May, up from 69. Greater consumer optimism should hopefully translate into stronger consumer spending in the second quarter. The Richmond Fed manufacturing index also rebounded to -2 from -6. While this was the second month in a row that manufacturing activity contracted, the improvements is a breath of fresh air for the sector. Finally, house prices increased 1.12% in March after rising 1.32% in February. This represents deterioration but for the first quarter, house prices are up 10.17% vs. 7.25% in Q4. As U.S. economic data continues to improve, expectations for tapering asset purchases by the Fed will continue to build and this sentiment should fuel further gains in the dollar. No major U.S. economic reports are expected on Wednesday.

CAD: Don't Expect Any Changes From BoC
The focus over the next 24 hours will be on Canadian dollar but we do not expect any significant increase in volatility for the CAD. The Bank of Canada will be making a monetary policy announcement and for the most part, the tone of the central bank will remain unchanged. Given that this is the last meeting led by outgoing BoC Governor Mark Carney, the chance of him shifting the central bank's bias one way or the other is extremely unlikely. With retail sales growth stagnating but the labor market improving, there also hasn't been enough improvement or deterioration in Canada's economy to warrant a change in monetary policy. Upside surprises in U.S. data should make the BoC a bit more optimistic however signals about future policy will be left to Stephen Poloz who takes the reins on July 1st. Of course, it won't be the last that we hear from Carney as he will be shipping out to the U.K. to guide monetary policy for the world's sixth largest economy, which is a big upgrade from the eleventh largest economy. The Australian and New Zealand dollars on the other hand ended the day almost unchanged against the greenback. This represents a sizeable intraday pullback for both currencies. Tuesday night's Australian leading indicators report was not expected to have a dramatic impact on the AUD.

The IMF's report on central bank purchases of gold is also getting some attention and even though the price of gold continued to fall, it is lending support to the beleaguered AUD and NZD. Investors have been eager to see whether the 18% decline in gold prices year to date attracted central bank buying and according to the International Monetary Fund, aside from Canada and Mexico, every major central bank has been hunting for bargains. Russia, Kazakhstan and Azerbajian collectively increased their gold holdings by 75%, cementing Russia's status as the world's number one buyer of gold. These three former Soviet Republics have been buying all the way down and while their demand has limited the slide in gold, it has not stopped it. For most central banks, buying gold is part of their overall forex portfolio diversification strategy and the further gold declines, the more demand we expect because central banks are not as sensitive to short or medium term swings as traders or even investors. The outlook for gold hinges on the outlook for the U.S. dollar and for the time being, expectations for a reduction in asset purchases by the Fed should keep the dollar bid. According to the CFTC's latest positioning data, fund managers and speculators are grossly short gold and we believe that the prices could head lower.

JPY: Hit By Weaker Data, Vulnerable To Stocks
Better than expected U.S economic data, the rise in U.S. stocks and the intraday recovery in the Nikkei last night drove the Japanese Yen traded lower against all of the major currencies. USD/JPY rose above 101 and then 102 to end the NY session near its highs. Last night's Japanese economic reports were actually a bit disappointing with small business confidence declining slightly. This may be only a hiccup in the longer road to recovery but it was nonetheless enough to drive Japanese stocks and the Yen lower at the onset of trading. The corporate service price index also fell more than expected, a sign that deflation is still a major problem in Japan. As for the Nikkei it opened down 1% but then quickly recovered all of its losses to end higher and this rebound sent USD/JPY soaring at the start of the Asian trading session. As we have seen, the Yen is extremely vulnerable to equity market volatility. Japanese retail sales figures are scheduled for release this evening. Demand is expected to rise 0.2% in April after falling 1.5% the prior month, which would be consistent with a continued recovery in Japan's economy.

GBP: Treading Water In Light Data Week
It is a quiet week for the British pound, which traded slightly lower against the U.S. dollar and slightly higher against the euro. U.K. markets were closed on Monday and no major economic data has been released over the past 48 hours. Sterling is under pressure in general after last week's surprisingly large decline in retail sales and dovish Bank of England minutes that basically left additional easing on the table. To put the lack of market moving U.K. event risk into perspective, the most important release on the U.K. calendar this week are housing numbers. Instead, sterling traders should keep an eye on the headlines as a handful of Bank of England policymakers are scheduled to speak. Nothing significant has come from Haldane or Tucker and Bean is scheduled to speak Wednesday. The Confederation of British Industry's sales index is expected Wednesday and we watch this number carefully because it has a strong correlation with the broader retail sales index. The rebound in May points to a potential recovery in spending this month -- a much needed dynamic that is essential in restoring GDP growth after the plunge in spending in April.

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

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