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US$ Settles into Quiet Ranges Ahead of Data

The US$ traded in rather flat ranges overnight as the market continues to digest yesterday’s benign US inflation report and ahead of US economic releases today. Yesterday, CPI was released at a much lower than forecast annual reading below 4.0%, despite record high energy prices and food prices climbing to 10-year highs. This data caused the market to pause in its mounting expectations of the timing of the Fed’s shift to a hawkish bias on rates. Futures markets have reduced their expectations of a Fed September rate hike to now 24.3%. Despite this weaker than forecast inflation data, the US$ remains well supported by the view that the US economy is emerging from its recent economic slowdown. Traders will certainly focus on US economic releases this morning to gauge the health of any such recovery. At 8:30 a.m., weekly jobless claims are to be released expected to push higher to 370,000 indicating continued sluggishness in the overall job outlook. At 9:00 a.m. TIC flow data is expected to show a decline of foreign inflows to $62.5 billion. 9:15 a.m.  yields the release of Industrial Production and Capacity Utilization data expected to decline 0.3% and register 80.1% respectively. At 10:00 a.m. the Philly Fed is to be released expected to register a gain to –19. Any signs that data releases today show continued bottoming in the economy should ultimately be US$ supportive, else look for the US$ to weaken in current ranges.

The euro continues to consolidate in recent ranges as traders look to a cessation of the widening interest rate differential between the US and Eurozone. This view gained traction as the Fed signaled last week that rates were likely to remain on hold and the US economy appears to be bottoming. Despite the Eurozone releasing data overnight showing that the economy grew 0.7% in the first quarter vs. expectations of a 0.5% gain, traders remain focused on the prospect that the Eurozone will slow significantly later this year. This has led some to speculate that ECB will push rates lower this year as the Bank aims to jumpstart economic growth. This should ultimately push the euro lower.

The yen continues to remain weak as traders focus on stability returning to markets and cautiously reintroduce risk to their balance sheets. With Japanese interest rates at 0.5%, traders continue to favor using the Japanese currency as a preferred vehicle to finance positions across other markets. Expect this trend to continue for some time as the yen will likely continue in its role as a proxy for market risk. The longer the period that calm descends upon markets, the greater the likelihood we see further prolonged yen weakness.

The pound also continues to have its fortunes ultimately determined by interest rate expectations. Currently, the market remains uncertain about the course of interest rate policy from the Bank of England amidst two very differing factors.  While inflation pressures continue to accelerate, the UK housing market continues to come under significant duress. This has forced the BOE to balance the benefits of inflation fighting with stimulating economic growth. The result has been uncertainty in markets as traders look to the Central Bank for direction, leading ultimately to sterling pushing lower.

US$ Better, But Falls Slightly After Inflation Data Lower than Forecasts

The US$ again rose overnight as traders focus on a bottoming US economy and the likelihood that the Federal Reserve has ceased its cycle of rate cuts. Comments yesterday from a slew of Fed officials all seem to assert that indeed US rates have ceased moving lower and now seemingly open the prospect of rate hikes later this year. Fed Governors Hoenig, Pianalto and Fischer each expressed concerns about inflation and rising prices. These comments have helped shift futures markets to forecast a 34.0% probability of a rate hike by the Fed’s September 16 meeting. This morning the market will shift its attention squarely to the release of CPI to gauge inflation levels in the US economy. CPI was released at a surprisingly weaker reading than many in the market had forecast, alleviating fears about runaway inflation and scaling back some interest rate expectations. CPI (ex food and energy) rose 0.2% month on month vs. expectations of a 0.3% reading. Year on year this data registered a 3.9% reading vs. expectations of 4.0% levels. These rather benign readings should relegate the US$ to its recent ranges and prevent any immediate rally.

The euro fell overnight as a perceived narrowing of interest rate differentials between the US and Eurozone coupled with comments from the French Finance Minister helped weigh on the common currency. With the Fed seemingly ending its cycle of rate cuts and the US economy showing signs of having bottomed, the market is now focused on Eurozone prospects. Recent economic indictors reveal that business confidence in France and Germany are beginning to wane as a strong euro and the effects of the global credit crunch are felt overseas. This has prompted many analysts to forecast that the ECB will be forced to abandon its inflation fighting policy stance and ease rates later this year, lessening the appeal of euro deposits. Also weighing on the euro overnight were comments from France’s Finance Minister Christine Lagarde who stated that she believes that the euro could be overvalued by as much 20.0% against the US$ on a fundamentals basis. These comments seem to assert the worries that Eurozone finance ministers are cultivating that the euro’s strength could contribute to significant economic malaise later this year.

The yen continues to remain under pressure as the Japanese currency remains the preferred financing vehicle for investors. As investors adopt more risk on to their balance sheets and into their portfolios amidst signs that the global credit crisis has eased, the yen has adopted a role as a proxy for this renewed risk. Expect this trend to continue for some time and with risk now being reentered into in the market, albeit cautiously, the yen will continue to remain under pressure.

The pound came under some modest pressure overnight after comments from the Bank of England Governor Mervyn King. King stated that the UK economy remains in a “fragile” state and that any further shocks to the system could push the economy to recession. He further stated that with inflation pushing above the Bank’s 3.0% inflation target, the scope of further interest rate cuts by the BOE is limited. These opposing comments will likely keep sterling in wide ranges fro some time.

US$ Firms Further After Retail Sales Data

The US$ rose overnight as a view overtakes the markets that the Fed has ended its cycle of rate cuts and that the US economy is nearing a bottom. This view will come sharply into focus later this afternoon when speeches by Fed members Hoenig, Yellen and Fisher all focus on the outlook for the US economy and the course of inflation and interest rate policy. With the Fed seemingly halting cutting rates, futures markets have assigned a 12.0% probability that US rates move higher to 2.25% at the September meeting. Traders will be watching the flow of US economic data this week. At 8:30 Import prices are to be released expected to gain 1.6%. In addition retail sales are to be released expected to decline 0.2%. Should this data show robust inflation pressures or better than expected consumer spending, expect the US$ to enjoy further gains.

The euro fell overnight, reversing most of yesterday’s gains as traders again focus on the likelihood of the interest rate differential between the US and Eurozone narrowing this year. Despite comments yesterday from ECB Chief Trichet that the current rate position of the Central Bank is adequate to counter inflation pressures, the euro reversed course overnight. This reversal is likely predicated on an emerging view that Eurozone growth rates will slow later this year, forcing the ECB into a more accommodative rate posture. This stance will be in sharp contrast to the US Fed and likely further decrease the appeal of the euro in favor of the greenback.

The yen continues to consolidate in ranges, as its direction remains ultimately defined by the “carry trade” and the market’s appetite for risk. With equity markets in Europe and Asia declining moderately overnight, the yen gained slightly. However, the ultimate course for the currency will be determined as investor appetite for risk grows. With the credit crisis seemingly nearing an end and the US economy appearing to weather the current economic slowdown, equity markets will likely soon again rise, financed with short yen positions leading the Japanese currency lower.

The pound fell overnight as traders focus on the likelihood that US interest rates are near a bottom and uncertainty continues to surround the course of UK Central Bank policy. With signs that inflation pressures are robust, while the housing market continues to shrink, UK policy makers will likely refrain from any policy decision for some time. This will certainly enhance the appeal of US$ assets as the Fed has all but signaled an end to rate cuts, ultimately weighing further on the pound.

US$ Falls Against Euro and Sterling, Rises Against Yen

The US$ gained against the yen and euro overnight while steadying against the pound amidst speculation that the worst is over for the US economic downturn and that the Fed has ceased its cycle of rate cutting. The market will certainly be watching the flow of US economic data this week to determine if these assumptions can be justified. There is no data slated for release today, while tomorrow sees the release of Import Prices and Retail Sales. Wednesday yields the release of CPI, while Thursday yields Weekly Claims, Empire Manufacturing, TICS data and Industrial Production and Capacity Utilization. Friday yields the release of housing starts and Michigan Confidence. Should this data prove resilient and in line with forecasts, it is likely that we will see the greenback continue to make significant headway across the board.

The euro continues to push lower against the US$ as signs seem to be emerging that the major Eurozone economies are showing signs of a slowdown, which could ultimately lead to some policy shift at the ECB. Recent indicators showing declines in business confidence in both France and Germany show that the economic malaise hampering the US for the last two quarters seems to be spreading to the Eurozone. This has led traders to speculate that the recent hawkish tone of the ECB surrounding interest rate policy will be altered as a slowdown encompasses the major economies of the Eurozone. With speculation emerging that rates could be pushing lower within Europe as the Fed steadies US policy, the appeal of Eurozone assets diminishes, likely to continue to weigh on the euro for some time.

The yen continues to steady in ranges as traders tepidly add risk to their balance sheets. With the yen remaining the preferred vehicle to finance positions across a broad spectrum of markets, via the “carry trade,” as market risk appetite ebbs and flows so do the fortunes of the Japanese currency. News last week from US insurance giant AIG that it was marking a significantly larger loss than had been forecast reignited fears that additional credit risk remains in the market. Until markets seemingly settle, the yen will continue to remain relegated to these ranges.

The pound rallied overnight after the release of data showed that UK producer prices surged in April, prompting traders to scale back bets that the Bank of England will move aggressively to cut rates. This has led traders to buy the pound as the likelihood of UK interest rates remaining amongst the highest in the G7 will prevails for some time given this acceleration in inflation pressures.

US$ Moves Lower in the Wake of Trichet's Comments, Dollar Rally Likely to Continue

The US$ gained overnight against the euro, while remaining relatively flat against the British pound and falling against the Japanese yen. The recent uptick in investor confidence surrounding the U.S. economy helped the US$ to gain over 3.3% on and indexed basis over the past two weeks. Today, the market will focus on the commentary from the European Central Bank to determine the US$’s direction. A slight shift in policy will not only help the greenback gain against the euro, but also be indicative that the slowdown is continuing to effect other economies, particularly as the U.S. economy is showing signs of rebounding. Data on initial jobless claims for last week was released at 8:30 a.m. The data was expected to show 370,000 jobless claims, slightly down from the 380,000 claims the previous week. Weekly claims came in slightly lower than expected, at 365,000. Continuing claims held stead at 3,020K.

The euro was lower overnight as the market increased expectations that ECB President Jean Claude Trichet will change his commentary following today’s ECB meeting. The ECB decided this morning to hold interest rates steady at 4.00%. During his initial comments, ECB President Trichet stated that anchoring price expectations remains the “highest priority.” At the same time, Trichet noted that the main risk is a more negative impact from the market turmoil of recent months. In the initial stages, it does appear that his comments mimic a more balanced approach to inflation and economic growth, rather than the previous statements that chiefly focus on preventing higher inflation. Trichet’s comments will take some time to filter their way into the market; however, it does appear that he is not providing the market with anything that would reverse the euro’s recent declines.

The Japanese yen gained versus the US$ following yesterday’s equity market declines. As equity markets continue to trade in a range, the yen will likely follow in the same pattern. Though the trend is eroding, the main force behind current yen strength remains risk aversion within the market. Increased confidence for the future has helped the US$ gain from its lows; however, markets remain concerned overall with the present state of the economy. Low interest rates in Japan will help any renewed confidence spark a renewal of the carry trade, which should lead to yen weakness across the board.

The British pound gained overnight against the US$ as the Bank of England did not lower interest rates. While this was largely expected within the market, many became concerned in recent days that the erosion in data would cause the Bank to move. The BOE does not issue any comments when it leaves rates steady, so the market will have to wait for the release of the minutes before it will become apparent if any more rate cuts are imminent in the U.K. Until then, the prospect for further rate cuts is likely to be a prohibitive factor behind the British pound substantially strengthening.