It has been an extremely quiet day in the foreign exchange market with currency pairs such as the EUR/USD and USD/JPY confined within a 50 pip trading range. This contraction in volatility has been occurring in the EUR/USD for the past few weeks and signals that a breakout is imminent - tomorrow’s U.S. retail sales report will provide the perfect catalyst. Based upon today’s price action which has seen most of the major currency pairs hold onto their recent gains, the odds favor an upside breakout. The strength of the Nasdaq, which hit fresh yearly highs 3 days in a row suggests that risk appetite, at least for U.S. assets remain healthy. Traders are sitting on the sidelines waiting for a reason to buy and if tomorrow’s retail sales report is strong, they will jump into the forex market with conviction.
Of all the economic data released this past week, Friday’s retail sales report is the most significant. The labor market is doing better than most people expected and now, traders will look for further confirmation of the U.S. recovery in the consumer spending report. Based upon the data reported by individual retailers, consumers did not disappoint. Nordstrom reported a 10 percent increase in same store sales while BJ’s Wholesale reported a 7.5 percent increase. Although the gains were not as impressive, Macy’s, Gap and Abercrombie all posted higher sales as well. The original fear was that the blizzards crimped consumer spending but after the NFP report, there is a good chance that economists may have underestimated consumer spending. Based upon the International Council of Shopping Centers and the Johnson Redbook same store sales reports, retail sales were very strong last month. However with two major snowstorms hitting the Northeast in February, a lot of stores were closed and many shoppers were stuck at home which is why economists are looking a very small rise in retail sales even though most individual retailers have reported strong gains. Consumption was so robust that, according to ICSC, retail sales grew the most since late 2007. With gas prices rising in February, the only argument for weaker spending is the snow and this argument has weakened significantly after the payrolls report. Despite the storms in the Northeast, the rest of the country picked up the slack. A stronger retail sales report would add to the upside momentum in the dollar. In addition the University of Michigan Consumer Sentiment report is also due for release and unfortunately, given the decline in the IBD consumer sentiment index, confidence may have deteriorated.
Last night’s economic reports from China were relatively firm with inflationary pressures rising strongly on both the consumer and producer level. Retail sales growth slowed slightly but industrial production accelerated. With consumer prices rising by the fastest pace in 16 months, some people believe that there is a heightened risk of monetary tightening by the central bank. However the last time the People’s Bank of China raised interest rates was in December 2007 and as recently as this week, Deputy Governor Su Ning said the government continues to implement a “moderate loose” monetary policy. With this in mind, the risk of tightening by the PBoC is low which explains why risk appetite held steady. Meanwhile even though the U.S. trade deficit narrowed in January, weakness beneath the headlines prevented the dollar from strengthening. The U.S. trade deficit shrank from -$39.9B to -$37.3B as exports fell for the first time since April while imports also dropped by 1.7 percent, the largest decline in 11 months. The contraction in imports and exports reflects weak demand both internationally and domestically. More specifically, import and exports of automobiles have decreased as the incentives offered by governments around the world to buy cars begin to fade. This mix is negative for the dollar because it does not play into the growth story. A smaller trade deficit is only dollar positive if it involves a larger increase in imports and a smaller increase in exports. What is particularly worrisome is that Americans imported the fewest barrels of crude oil in 10 years. Traders were also slightly disappointed by the jobless claims numbers which showed a smaller decline in jobless claims and higher continuing claims. We don't believe that traders should make too much of the jobless claims numbers because weekly claims are still at the lowest levels in 2 months and continuing claims increased only because they fell to the lowest level in more than a year the prior week.
EUR/USD: CAUTIOUS TONE IN ECB MONTHLY REPORT
For the second day in a row, the euro edged higher against the U.S. dollar despite a relatively subdued monthly report from the European Central Bank. According to the ECB, rates are appropriate and inflationary pressures are low. Even though the central bank expects to gradually withdraw monetary stimulus, an uneven and moderate recovery is expected given their uncertain outlook. Compared to the rest of the world, the Eurozone faces relatively unique risks and the big deficits in particular will “place extra burden on monetary policy.” These comments echo the remarks made by ECB President Trichet earlier this month and confirm that the ECB won’t be jumping the gun by aggressively tightening monetary policy before the risks of sovereign defaults subside. Eurozone industrial production numbers are due for release tomorrow and given the rise in German and French manufacturing activity, we expect a pickup in the region as a whole. Meanwhile, although the Swiss National Bank left interest rates unchanged at 0.25 percent, comments from SNB President Hildebrand sent EUR/CHF sharply higher in the minutes following the announcement as he warned that they will act decisively to prevent excess franc appreciation. The SNB increased their growth and inflation forecasts but any optimism from this change was offset by their comment that deflation remains a danger and the recovery remains fragile. Overall, the comments from the SNB suggest the central bank is no closer to raising interest rates now than 3 months ago.
GBP/USD: BRITONS SEE STRONGER INFLATION PRESSURES
After falling for 3 consecutive trading days, the British pound has finally staged a relatively respectable rally following the release of the Bank of England’s Inflation Attitude survey which showed that inflation expectations increased to the highest level since November 2008. According to the report, the annual rate of inflation expected for this coming year is 2.5 percent compared to a prior estimate of 2.4 percent. Inflation seems to be the central bank’s biggest problem, but given that they expect weak demand to drive down inflation, the latest report will not pressure the BoE to tighten monetary policy. Don’t forget that there have recently been major disappointments in U.K. economic data. With no additional reports or economic data due from the U.K. tomorrow, the British pound will most likely key off U.S. data. The possibility of further gains is high because pound short positions are at extreme levels, raising the risk of a short squeeze.
USD/CAD: EMPLOYMENT NUMBERS ON TAP
The Canadian and Australian dollars ended the day virtually unchanged against the greenback despite stronger Canadian data and weaker Australian data. The Canadian trade balance rose from 0.1B to 0.8B in the month of January thanks to a 0.5 percent gain in exports and a 1.7 percent decline in imports. Capacity utilization also increased from 68.7 to 70.9 percent, pointing to increasing productivity in Canadian corporations. House prices grew 0.4 percent, right in line with market expectations and in line with the strong recovery in the housing market. Canadian employment numbers are due for release tomorrow and given the sharp rise in employment the prior month and the decline in the employment component of IVEY PMI, we expect Canada to report weaker job growth in February. A similar situation happened in Australia, where job growth was much weaker than the market had expected after the blockbuster numbers the prior month. With only 400 jobs created against expectations of 15,000 jobs, the labor market in Australia appears to be cooling, but with a sharp rise in job advertisements, we believe that this is will only be a temporary dip. Meanwhile mixed consumer spending numbers from New Zealand failed to help the kiwi turn higher. Retail sales rose 0.8 percent in January but excluding auto purchases, sales only increased 0.3 percent. There was also a big downward revision to the prior month’s report, which indicates that perhaps the RBNZ has sufficient reasons to remain dovish.
USD/JPY: GDP REVISED DOWNWARD
There was no consistency in the performance of the Japanese Yen crosses as the Yen weakened against the euro, British pound and Swiss Franc, strengthened against the kiwi and ended the day unchanged against the U.S., Canadian and Australian dollars. This suggests that despite the rally in U.S. equities, there has only been a small improvement in risk appetite. Japan released its final GDP numbers last evening and according to the report, the Japanese economy grew at a slower pace than originally predicted in the fourth quarter. GDP increased by 0.9 percent, compared to a prior forecast of 1.1 percent. A drop in private-sector inventory along with weaker than expected spending by businesses caused the downward revision. Finance Minister Naoto Kan used the disappointing figures in his continuous agenda to influence the Bank of Japan. Kan said, "By making efforts and by sharing the common goal with the BOJ, I want to bring the rate of price changes into a positive territory within this year if possible.” The PCE deflator fell by 2.8 percent in Q4, which indicates that deflationary pressures are persistent. The Bank of Japan who meets for an interest rate decision in the next week may decide to expand their balance sheet to achieve positive price growth. According to two unknown central bank officials, the BOJ may expand a ¥10 trillion or $110 billion funding to banks. Government officials are not optimistic on the outlook for the Japanese economy. According to government spokesman Hirano, the economy is still in a sever condition despite positive growth.
EUR/USD: Currency in Play for Next 24 Hours
The currency in play for the next 24 hours is EUR/USD. Euro-zone’s Industrial Production is expected to be released at 11:00GMT or 6:00AM EST. Shortly after, Retail Sales will be announced from the U.S. at 13:30GMT or 8:30AM EST. After bottoming out in early February, the EUR/USD has been consolidating and today, the pair has finally managed to edge itself into the Buy Zone which we determine using the Bollinger Bands. The next level of resistance for the pair is second standard deviation at 1.3735; the level becomes more important if upper bound of triangle formation is breached. The first standard deviation located at 1.3545 will act as a level of support.
