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How Will The Markets React?

Consumption growth in the US is anticipated to remain strong during the month of August, as advance retail sales are estimated to rise 0.5 percent from the month prior, while sales excluding autos should pick up a milder 0.2 percent. Thus far, US retailers have performed fairly well despite a recession in the housing sector and deteriorating labor market conditions, as the International Council of Shopping Centers (ICSC) recently reported that August chain-store sales saw a 2.9 percent increase from last year. However, it appears that most of the improvements came as a result of massive discounting, as chains like Wal-Mart and Macy’s have slashed prices in order to draw customers, which has the potential to slim-down profit margins. Retailers won’t be able to use these tactics forever, and a slowdown in consumption is likely to show through eventually. Even retailing executives are leery about the outlook. Last week Myron E. Ullman, chief executive of JC Penney said, said in reference to shoppers’ anxiety about the economy, “It will be tougher than it is now. I do not see anything on the horizon that will turn this around.” With the US consumer responsible for almost 70 percent of GDP, the risks for a sharp slowdown in economic expansion in Q3 and Q4 rise dramatically. Nevertheless, a resilient retail sales report should give the US dollar and equities and boost in the near-term.

Bonds – 10-Year Treasury Note Futures

10-year Treasury note futures have faced steady pressure since hitting a high of 110-31 on September 10th, as the contracts continue to make their way towards trendline support at 109-21. That line has been in effect for the past several weeks and has effectively stopped each decline. While we are likely to see range-bound trading ahead of Tuesday's FOMC meeting, Friday’s retail sales report adds event risk, with a particularly strong reading providing a bearish bias for Treasuries.

10-Year Treasury Note Futures (Daily Chart)

FX – EUR/USD

With EURUSD still trading near record highs around the 1.3900 level, many traders have been left wondering how much lower the greenback can possibly fall. Given the ramped up speculation regarding the possibilities of a rate cut by the Federal Reserve on September 18th, targets of 1.4000 do not seem unreasonable. Nevertheless, with the release of US retail sales anticipated to improve on Friday, the greenback could see a substantial boost. Figures from many retailers for the month of August have already highlighted steady sales during the back-to-school season, despite deteriorating labor markets and a housing recession. However, many retailers have also reported that the sales gains were the result of massive discounting, which cannot go on forever given the practice’s negative impact on profit margins. Regardless, forex traders will likely respond in a somewhat short-sighted manner and take EURUSD down to test 1.3785, especially if the sales figure is better-than-expected and quells speculation of a rate cut by the Fed. On the other hand, a particularly disappointing retail sales release could potentially send EURUSD up to test 1.4000.

EUR/USD (Daily Chart)

Equities – Dow Jones Industrial Average

US equities have started to slowly recover since the Dow plummeted to a low of 12,517.94 on August 16th, as traders have ramped up speculation of a rate cut by the Federal Reserve on September 18th. Price has formed an ascending channel as investors become more optimistic, and with US retail sales expected to show strong readings on Friday, the Dow could make a move higher to test the resistance trendline near 13,600. However, if the consumption report proves to be disappointing, shares could sell off rather quickly and send the equity index plummeting towards 13,000.

Dow Jones Industrial Average (Daily Chart)

Written by Terri Belkas, Currency Analyst of DailyFX.com