Cross Road for USD and US Stocks

• Cross Road for USD and US Stocks
• EUR - ECB Meeting Next Week
• NZD - Below 80 Cents
• CAD - Sharp Rise in Q1 GDP
• AUD - Oil Prices Plunge, Gold Lower Too
• GBP - Uneven Data Should Lead to Steady Policy
• JPY - Latest Data Shows Continued Recovery in Japan

Cross Road for USD and US Stocks

We are currently at a cross road for the U.S. dollar and U.S. stocks. The S&P 500 dropped 1.4% today and the Dow Jones Industrial Average experienced its largest one-day slide in 5 weeks.  One day of weakness does not make a trend, but if next week's U.S. event risks surprise to the downside, the sell-off in stocks could mark a near term top for equities which will impact the performance of currencies. The greenback extended its losses against the Japanese Yen today but appreciated against other major currencies.  FX traders are in the midst of trying to figure out whether to buy or sell the dollar when stocks fall.  For most of this week, lower stocks have meant a lower dollar as investors reduce exposure.  However today that dynamic changed with the dollar rising against higher beta currencies such as the EUR, GBP, AUD and NZD.  The question of what becomes the broader driver of dollar flows also lies in next week's reports. The primary reason why investors loaded up on U.S. dollars was because of their belief that the Fed will dial back asset purchase sooner rather than later.  This will be largely dependent on next week's non-farm payrolls report. If job growth continues to increase, then the dollar could become the beneficiary of safe haven flows.  However if payrolls growth contracts suddenly, then both the U.S. dollar and U.S. stocks could fall in unison. 

Today's U.S. economic reports were mixed. Personal incomes failed to grow in the month of April while personal spending dropped 0.2%, the first decline since May 2012.  It may be good behavior for consumers to cut spending when incomes are flat lining but lower consumption is not conducive to growth.  The PCE Deflator also declined for the second month in a row, a sign that inflationary pressures remain low.   However the dollar recovered when the Chicago PMI index surged to its highest level since March 2012.  With manufacturing activity slowing in the NY and Philadelphia regions, investors were bracing for the worse and when the data surprised to the upside, they rallied the dollar in relief.  The recovery in the greenback was further support by the upward revision in the University of Michigan's Consumer Confidence index.  The preliminary numbers showed that consumer sentiment improved significantly in May but the revision took the index to its highest level since July 2007, or more than 5 years.  Unfortunately when U.S. stocks turned negative, USD/JPY reversed course again.  Today's economic reports were mixed and this means for the time being, the Fed remains on track to taper asset purchases this year. Their bias will only change when the disappointments start to rack up.Uber doves Rosengren, Dudley and Bernanke have made it clear that they feel changes can be made in the next few months. 

EUR - ECB Meeting Next Week

The euro ended the day lower against the U.S. dollar ahead of next week's ECB meeting. Based on the deterioration in this morning's German retail sales report and this week's German unemployment numbers, the European Central Bank will maintain a bias to ease.  Whether they follow through remains to be seen but for the time being, these reports should harden the central bank's commitment to additional stimulus. German retail sales dropped 0.4% in the month of April after falling 0.1% in March.  Consumer spending in France also declined 0.3% after rising 1.3% the previous month. Collectively these numbers show that consumer sentiment is being hampered by high unemployment and sluggish growth.  The big story affecting the euro today were Bank of Italy Governor's comments on the potential for another rate cut. Since Iganzio Visco is also a member of the ECB Governing Council his views are important.  However these comments are not new which is part of the reason why the EUR/USD bounced off its lows. Earlier this month Visco said the central bank was "technically prepared" to introduce negative deposit rates.  The real question is if other policymakers feel the same way and based upon recent comments from the central bank, there is a growing consensus favoring additional stimulus especially after the larger than anticipated decline in German retail sales last month.  We feel that the ECB is far more willing to signal their intention to lower rates than to actually follow through with it.  The bar is high for negative deposit rates and they would want to see the PMIs decline again before pulling the trigger.

NZD - Below 80 Cents

The New Zealand dollar was both the day's biggest mover and its worst performing currency.  NZD dropped over 1.5% against the U.S. dollar, nearly 2% against the Japanese Yen and 1% against the euro.  You wouldn't be able to tell by the movement of the currency that economic data was actually good.  Business confidence rose to its highest level since July 2011.  Instead, NZD extended its slide after the Reserve Bank threatened to intervene in the currency this week. In fact, we would not be surprised if they were in the markets today buying the currency but since the bulk of the move happened between 6pm and 8pm local time in Auckland, they may not be responsible.  Meanwhile the Canadian and Australian dollars also extended lower despite better than expected Canadian data. Canadian GDP grew at an annual rate of 2.5%, the fastest in six quarters but despite the stronger data, the loonie declined against the US dollar as oil prices dropped 2%. In the GDP report exports were the largest contributor to growth. Exports of goods and services rose 1.5% after four weak quarters in 2012. Mining and oil and gas extraction was the primary source of industrial growth in the first quarter. This first quarter growth gives the Bank of Canada's projection of 2.1% growth in 2013 a sturdy start. No major economic reports were released from Australia but that will change next week with the country's PMI numbers scheduled for release and the Reserve Bank holding a monetary policy announcement.

GBP - Uneven Data Should Lead to Steady Policy

The reversal in U.S. stocks caused the British pound to give up its gains against the dollar but the currency still managed to edge higher against the euro.  Today's U.K. economic reports did not add to the improvements seen in house prices and for that reason, the Bank of England is widely expected to leave monetary policy unchanged next week. The unevenness in the U.K.'s economy should lead the BoE to postpone any major decisions even if we get a big surprise in next week's PMI numbers.  Reports on the manufacturing and service sector are key. If manufacturing and service sector activity increase for the third straight month, the chance of additional easing by the BoE will decline.  As for today's releases, UK mortgage approvals were expected to rise to 54,600 but increased only marginally from 53,674 to 53,710. The Bank of England revealed that consumer credit rose 0.5B pounds in April, down from 0.6B pounds in March. The only unambiguously good news was in the GfK consumer confidence index which rebounded to -22 from -27 this month. This improvement was better than expected and prompted the British Chambers of Commerce to forecast that the UK economy will grow faster than expected over the next three years but they still warned that, "This does not change the fact that economic growth is still too weak, and the pace of recovery will remain unduly slow for a while yet."

JPY - Latest Data Shows Continued Recovery in Japan

The sell-off in U.S. and European equities drove the Japanese Yen lower against all of the major currencies but not before some exaggerated intraday volatility. USD/JPY initially hit a 3 week low after softer personal income and personal spending numbers, then rebounded to 101.30 after stronger Chicago PMI and the UMich survey.  Unfortunately USD/JPY failed to hold onto its gains as the selling of U.S. stocks gained momentum.   Last night's Japanese economic reports were mostly better than expected with industrial production jumping 1.7% and manufacturing activity ticking higher according to the PMI.  Inflationary pressures also eased with national CPI growth rising from -0.9% to -0.7%.  These reports indicate that Japan's recovery did not lose momentum in the month of April as earlier reports suggest.  Yesterday we discussed a potential reason for why Japanese investors are not selling foreign bonds (weak Yen encourages repatriation) and Reuters carried an interesting story overnight that extends this thought further.  While the Government's Pension Investment fund is planning to re-examine its portfolio strategy, the mix of their portfolio may not change. This suggests that the fund may choose to not boost its holdings of foreign bonds despite the central bank's concerted effort to drive down yields.  No verification has been made by GPIF, but this story is not positive for USD/JPY.