·         US Retail Sales Will Determine if the Bottom in EURUSD is Real

·         ECB Officials Continue to Talk of More Rate Hikes

·         Yen Traders Look Ahead to BoJ Monthly Report and Fukui Comments


US Dollar


Seven days of consecutive weakness has once again proven to be the most that the EUR/USD could handle.  The dollar started the day on a softer footing even before US data hit the tape.  To the surprise of the market, the trade deficit widened to record levels once again in the month of August.  With oil prices remaining stubbornly high and above $70 for most of the month, the import bill continued to rise.  At the same time, imports from China continued to grow despite the recent appreciation in the Yuan.  This makes the gap between US trade related outflows and foreign investment related inflows even more difficult to close.  If you recall, the Treasury's net foreign purchases report was extremely weak for the month of July.  Foreign demand for US assets is expected to rebound in August thanks to the rally in stocks, but if it does not jump significantly, we would have two months of funding deficiencies, which would be a problem for the dollar.  The TIC report is due next week.  The sell-off in the dollar was relatively modest because most traders expect the imbalance to improve in the months ahead, reflecting the sharp fall in oil prices that we have seen in September.  Aside from the weak trade balance this morning, the Fed’s Beige Book report also disappointed traders by not containing the same hawkish tone as the FOMC minutes released yesterday.   According to the various Fed districts, economic activity was mixed across the nation.  Sales of interest rate sensitive goods such as cars and homes have been sluggish but consumer spending overall is picking up.  Even though the job market is still relatively healthy, inflation is not much of a concern as wage and price pressures remain relatively well contained.  Four of the Fed districts saw firmer growth, but a couple of the districts also reported cooler growth.  At this point, the US dollar is reaching critical resistance levels. A true top in the mighty buck will be dependent upon tomorrow’s consumer spending data.  Judging from recent reports, retail sales have a greater risk of coming out stronger than weaker.  Earlier in the week, both same stores sales and the Redbook retail sales reports were particularly strong.  Over the past two days, we have not only seen the positive comments on consumer spending in the Beige Book report, but also in yesterday’s comments from President Lacker.  




In contrast to the US, where everyone is trying to forecast if and when the Federal Reserve will begin to cut interest rates, in the Eurozone, the direction of interest rates and the message of the central bank is very clear.   As if we did not hear them the first time,  one after another, ECB officials have been telling the markets that interest rates remain very low and monetary policy remains accommodative.  Quaden was the latest council member to do so.  He added that another rate hike before the end of year is “very likely.” The central bank’s monthly report reiterated a similar message.  This means that even if inflation is falling globally and Germany, the Eurozone’s largest member country faces some risks to growth in the year ahead, the ECB will still be raising interest rates again this year.  This should keep the Euro relatively bid against other currencies where the interest rate premium gap is closing in on 1 percent or less, such as EUR/CAD and EUR/GBP. 


British Pound


After yesterday’s hawkish comments from Bank of England Governor King, the British pound started to bottom out against the US dollar.  We saw further strength today on the back of mildly hawkish comments from Sentence and Besley, the new MPC members.  Like King, they were concerned about whether any drop in inflation would last.  This suggests that they leaning closer to raising rates again, especially if economic data begins to turn up.  The housing market is continuing to stabilize as the RICS house price balance increases from 35 percent to 45 percent.  Tomorrow’s FT house price data should reflect a similar condition.  The only question is whether we see a pickup in wages and consumer spending as a result of that. 


Japanese Yen


The Japanese Yen is beginning to turn against the US dollar, but the sustainability of this turn will be dependent upon whether we hear hawkish comments from Bank of Japan Governor Fukui tonight along with a more positive outlook in the central bank’s monthly report.  This has strong possibility of happening, especially since Japanese companies have benefited greatly from the weakness of the Yen.  The value of the Yen not only helps to boost exports, but it also makes it easier for the central bank to raise interest rates.  Therefore the BoJ could acknowledge the yen’s benefits as well as resurrect the talk of the possibility of an interest rate hike next year.  However politics continue to be a major risk for the Yen.  Japan has instituted new financial sanctions that would freeze transfer of funds to groups that may have links to North Korea and is barring all North Korean ships from entering Japanese ports.  Trade between Japan and North Korea is relatively small, but tensions between the two nations are not.