A US Market Condition That's "Not Sustainable"
Despite rampant volatility and steep US dollar losses, investor appetite has remained surprisingly strong, suggesting the markets are ignoring important and potentially perilous global developments.
Thursday was another very active day in the foreign exchange market with the US dollar (USD) trading lower against all major currencies. Most of the action was in the Japanese yen (JPY), but the recovery in US stocks and the moves in the dollar also received some attention.
The selloff in the dollar, decline in US Treasury yields, and rise in the S&P 500 suggests that investors were happy to see retail sales increase, but felt that the rise in spending was not strong enough to boost the Federal Reserve’s case for tapering asset purchases.
The highly touted article by Wall Street Journal columnist Jon Hilsenrath that kicked off the sharp end-of-day rally in US equities comes to a similar conclusion, albeit from a different angle. Hilsenrath quotes Jan Hatzius, chief economist at Goldman Sachs, as saying "The fundamental economic outlook really hasn't changed much, but we are getting more worried about Fed policy."
According to the latest economic reports, the recovery in the labor market is finally fueling momentum in consumer spending. Retail sales increased 0.6% in the month of May, up from 0.1% in April, but excluding autos and gas, retail sales rose only 0.3%, down from 0.5% the previous month. Sales in April were also revised down from 0.6% to 0.5%.
In other words, today's report on consumer spending was not unambiguously positive for the greenback.
US investor appetite remains surprisingly resilient in the face of major losses in Asian markets. Perhaps investors are starting to look at individual countries as isolated entities that are unaffected by global developments, and though it is hard for us to believe this mentality is sustainable, that's what we are seeing in the markets right now.
A number of US economic reports are scheduled for release on Friday, and if the data surprises to the upside, investors could glean more reasons to ignore the volatility in the other markets and remain in denial.
While Hilsenrath's article is negative for the dollar, it isn't overwhelmingly positive for stocks, either. This is because his conclusion that the Fed is nowhere near raising interest rates is based on the thesis that the US economy is not strong enough to handle it.
Producer prices, first-quarter current account balance, the Treasury's international capital flow report, industrial production, and the University of Michigan's consumer sentiment reports are all expected on Friday, so keep an eye on the US dollar because it will be in play.
Of these releases, we feel that the U of M survey could be the most market-moving because it would give a sense of whether Americans have been affected by the turn in stocks and the slowing US recovery.
JPY: Will the Bank of Japan (BoJ) Cry Uncle?
While the Japanese yen crosses ended the day off their lows, the yen is higher against most major currencies. With USDJPY falling almost 1000 pips from its peak on May 22 to its low on Thursday, the question many FX traders are asking now is when the Bank of Japan (BoJ) will give in and initiate new easing measures.
See related: What the Bank of Japan Is Really Waiting for
ECB Releases Its Latest Monthly Report
The euro (EUR) ended Thursday marginally higher against the US dollar after all of the action was concentrated in the yen crosses and commodity currencies. The only notable release from Europe was the European Central Bank (ECB) monthly report, which indicated no forthcoming changes to the ECB’s low interest-rate policy anytime soon.
Price developments should remain in check with price stability over the medium term. Eurozone CPI is the only piece of Eurozone data on the economic calendar for Friday.
2 “Much-Needed” Short-Covering Rallies
The Australian (AUD), New Zealand (NZD), and Canadian dollar (CAD) all rebounded against the greenback on Thursday with the AUD and NZD enjoying the strongest recoveries. While Australian economic data surprised to the upside, the primary driver of the rally in both of these currencies has been short covering. AUD and NZD have become deeply oversold in recent weeks and are due for a much-needed recovery.
Canadian data, on the other hand, continued to surprise to the upside as the new housing price index rose 0.2% in April.
This week’s Reserve Bank of New Zealand (RBNZ) downgrade to GDP growth failed to have a lasting impact on the NZD. Thursday night, we have the business PMI index scheduled for release, and it will be interesting to see if New Zealand businesses have grown less optimistic in the face of a rising currency.
The Bank of England’s Newest Challenge
The British pound (GBP) ended Thursday unchanged against the euro and US dollar. The UK’s funding for lending scheme (FLS) has come under fire, and incoming Bank of England (BoE) Governor Mark Carney and Chancellor of the Exchequer George Osborne may have to consider new ways to boost lending.
Former BoE policymaker Adam Posen has openly said the UK’s funding for lending scheme has been "disappointing." Posen said the lending plan is not working properly because it involves banks that are still not back up on their feet from the previous crisis and suggested that the BoE should purchase other securities besides UK government bonds.
By Kathy Lien of BK Asset Management
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.