Dollar, Yen to Advance as Risk Aversion Grips Currency Markets

Key Overnight Developments

• Reserve Bank of Australia Holds Rates at 4.5 Percent as Expected
• UK Retail Sales Accelerated But Outlook Remains Dour, Says BRC
• Australian Independents Back PM Gillard Votes to Form Government
• Bank of Japan Maintains Monetary Policy, Rhetoric Unchanged

Critical Levels

The Euro and the British Pound declined in overnight trade, with the single currency down 0.7 percent while sterling came off 0.2 percent as stocks declined, boosting demand for the safety-linked greenback. The Euro saw outsized losses after the Wall Street Journal reported that European stress tests conducted in July had understated lenders’ holdings of potentially risky sovereign debt, seemingly reinforcing our initial suspicions. We remain short EURUSD.

Asia Session Highlights

UK Retail Sales grew 1 percent in the year through August according to a report from the British Retail Consortium, topping the previous month’s 0.5 percent increase. BRC Director General Stephen Robertson issued cautious commentary despite the improvement, noting “this better growth is compared with a very poor performance a year ago and sales were often [discount-driven].” Robertson added that “anxiety about job cuts and tax rises is putting people off making major spending commitments.”

The Bank of Japan d unanimously decided to keep interest rates unchanged at 0.10 percent. The bank lending facility remained at 30 trillion yen while monthly government bond purchases remained at 1.8 trillion yen, all as expected. Indeed, the commentary following the release was near-identical to the rhetoric offered following the “emergency” meeting on August 30.

The Reserve Bank of Australia kept interest rates unchanged at 4.50 percent as expected. RBA Governor Glenn Stevens said the current setting is “appropriate for the time being” with economic growth likely to be close to trend and inflation close to target all the while the global outlook remains “somewhat uncertain”. Notably, Stevens acknowledged the likelihood of a broad-based downturn ahead, saying global growth will “probably ease” over the coming year while expansion in China – Australia’s largest trading partner – is moderating as monetary conditions there become less accommodating. Commenting on inflation, Stevens repeated the now familiar refrain warning that annualized CPI readings may top 3 percent “for a few quarters” through to mid 2011 due to changes in tobacco taxes. The Australian Dollar largely ignored the announcement with the outcome having been priced in well ahead of the release according to a Credit Suisse gauge of policy expectations.

Separately, independent Australian lawmakers Robert Oakeshott and Tony Windsor announced they would support current Labor party Prime Minister Julia Gillard, giving her the necessary votes to form a government after a general election in mid-July produced inconclusive results. A third independent parliament member – Bob Katter – came out in favor of the Opposition leader Tony Abbott.

Euro Session: What to Expect

Switzerland’s Unemployment Rate is expected to remain unchanged at 3.6 percent in August, snapping six consecutive months of consecutive declines. The outcome follows last week’s disappointing PMI figures that showed manufacturing activity unexpectedly dropped off to the slowest since February, hinting the export-dependent mountain nation may not be able to sustain the robust performance noted in the second quarter as its top trading partners in the Euro Zone begin to face headwinds from austerity measures and debt issuance amid attempts unwind their debt burden.

German Factory Orders are set to add 0.5 percent in July, pushing the annual growth rate lower to 20.6 percent, the lowest since January. Germany is the world’s second-largest exporter so weakness here would reinforce fears of a broad-based global slowdown in the second half of the year and may open the door for a return to market-wide risk aversion.

Turning to sentiment, S&P 500 stock index futures are down 0.2 percent in late Asian trade, suggesting the path of least resistance points toward risk aversion that promises to boost the safety-linked US Dollar and Japanese Yen against their top counterparts.

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