New Zealand Dollar Soars on First Rate Hike in 3 Years

• Will the Dollar be Crushed by Retail Sales?
• New Zealand Dollar Soars on First Rate Hike in 3 Years
• AUD: All Eyes on AU Employment
• CAD: Oil Prices Extend Losses
• EUR: Touches 2-Year Highs Despite Weaker IP
• EUR/GBP Climbs to 2-Month Highs
• Yen Crosses Pressured by Weaker Data and Decline in Nikkei

New Zealand Dollar Soars on First Rate Hike in 3 Years

For the first time in 3 years, the Reserve Bank of New Zealand raised interest rates by 25bp to 2.75%.  While the decision was widely expected, the New Zealand dollar still traded sharply higher because the central bank raised its inflation and growth forecasts and said rates will rise by 2% over the next 2 years.  According to Governor Wheeler, today's rate increase was needed to keep a lid on inflation, which is becoming a bigger problem with inflationary pressures on the rise. The central bank now projects inflation to rise to 1.9% instead of a previous forecast of 1.5%.  With confidence high among consumers and businesses, investment intensions and hiring are expected to improve.  The prospect of continued momentum in the economic expansion also led the RBNZ to raise its 2015 GDP forecast from 2.8% to 3.2%.  The central bank warned that current levels of the exchange rate not sustainable but these were the exact same words used at the last meeting and clearly the exchange rate has not prevented the RBNZ from tightening.  Not only has New Zealand become the first major economy to raise interest rates but they signaled that today's move represents the beginning of a longer term tightening phase. Therefore we expect the New Zealand dollar to extend its gains, climbing to fresh 1-year highs versus the greenback in the near term. Meanwhile the Australian and Canadian dollars ended the day unchanged to slightly higher against the greenback. This move represents a significant intraday recovery for both currencies.  During the European trading session, AUD/USD was hit hard by a decline in copper prices and the Chinese Yuan, which dropped to its lowest level since June.  The rally in gold helped to support AUD but the currency is still being plagued by softer economic data.  Consumer confidence fell for the fourth month in a row while home loan growth stagnated in January after falling a downwardly revised 3.3%.  Investment lending also dropped 3.3% after rising 2.5% the previous month.  Slowing domestic and external growth has taken a big toll on the housing market and tonight's employment report really needs to surprise in a big way to prevent investors from seriously questioning the Reserve Bank of Australia's judgment in dropping their easing bias.  Job growth is expected to rebound after contracting in January. The Canadian dollar on the other hand received no support from a rise in house prices as oil prices continued to tumble. 

Will the Dollar be Crushed by Retail Sales?

After days of listless trading, we finally have some tier 1 U.S. economic reports to guide new direction in the forex market. Retail sales are scheduled for release on Thursday and if USD/JPY wants any chance of recapturing 103 in the near term, consumer spending needs to turn positive in the month of February.  We know the labor market improved last month and the Federal Reserve is committed to tapering but the missing link has been spending.  Retail sales declined in December and January with spending falling the most since 2012 in the first month of the year. A third monthly contraction would drive the dollar lower in the near term but the greenback won't be crushed by a soft release because unless spending falls by 1.5% or more, it would not change the central bank's monetary policy plans.  Economists are looking for a small rebound but based on the decline in sales reported by Redbook and the International Council of Shopping Centers the risk is for a downside surprise.  The cold winter would have boosted spending on electricity and gas but lower consumption of other products such as vehicles should offset that.  Investors have been hanging tight throughout the week ahead of the retail sales report.  Today, the greenback traded lower against most of the major currencies but if consumer spending rises for the first time since November, we can expect a renewed rally in the dollar.  The biggest beneficiary should be USD/JPY, which we expect to retake 103.  In addition to retail sales, the weekly jobless claims report and import prices are also scheduled for release. Jobless claims dropped to their lowest level in 3 months last week so a bounce is expected but if claims continue to fall, it would support or add fuel to the dollar rally. 

EUR: Touches 2-Year Highs Despite Weaker IP

Despite weaker economic data and decline in European stocks, the euro touched the 2-year high that it set last week against the U.S. dollar.  The currency pair's strength was driven by an intraday recovery in U.S. stocks and general improvement in the Eurozone economy.  Since the European Central Bank upgraded their 2014 GDP forecasts last week, EUR/USD traded extremely well against the British pound, U.S., Canadian, and Australian dollars. This morning's surprise decline in Eurozone industrial production failed to halt the currency pair's rally.  Given the strength of German IP, activity in the Eurozone was expected to rise 0.5% in January but instead it declined for the second month in a row by 0.2%.  This weakness was concentrated in countries such as Latvia, Lithuania, the Netherlands and Finland.  France also saw industrial production decline but less than the previous month.  Germany, Italy and Spain all experienced an uptick in manufacturing activity at the start of the year.  A number of ECB officials also spoke this morning and they reiterated the central bank's pledge to take action if necessary. ECB President Draghi speaks tomorrow and his comments are particularly important with the euro trading near 2-year highs.

EUR/GBP Climbs to 2-Month Highs

The British pound extended its losses against the euro but consolidated versus the U.S. dollar.  For the past 5 trading days, EUR/GBP has moved higher and is now trading at its strongest level in more than 2 months.   With the British pound falling victim to profit taking and euro benefitting from stronger German data and optimism from the ECB, the recent strength in EUR/GBP could take the currency pair towards 85 cents. The only piece of U.K. data released today was the National Institute of Economic & Social Research's GDP estimate, which was revised up from 0.7% to 0.8%.  The outlook for the U.K. economy remains bright but with no major economic reports scheduled for release over the next week, overstretched positioning could lead to more profit taking.  Tomorrow the trade balance will be released and despite an improvement in industrial production and manufacturing activity, the trade deficit is expected to widen which would be negative for sterling.

Yen Crosses Pressured by Weaker Data and Decline in Nikkei

The decline in U.S. yields and sharp sell-off in the Nikkei overnight prevent USD/JPY from rallying today.  In fact all of the Yen crosses with the exception of EUR/JPY and CHF/JPY traded lower.  For Japan, the weakness was driven by a combination of softer economic data and a continued decline in the Chinese Yuan.  Despite the Bank of Japan's confidence in the economy, consumer confidence dropped to its lowest level since September 2011. The largest decline was in the subcomponent that measures the willingness of consumer to buy durable goods.  76% of households surveyed also expect prices to rise in the next 12 months, which is not unexpected considering the prospect of higher taxes next month.  We continue to believe that the central bank may be overestimating the resilience of consumers and how much they have discounted the tax increase in their household purchasing plans. Based on the drop in sentiment we can expect a pullback in demand when taxes are raised by 3% next month.  If wages can keep up it is less of a problem but according to the latest report, labor cash earnings declined in the month of January. The drop in the Domestic CGPI index is a sign that inflationary pressures are easing.  However not all news was bad news, the BSI's large all industry and manufacturing indices increased in the first quarter, reflecting a pickup in business activity.  Machine orders are scheduled for release this evening and a rebound is expected after a pullback at the end of last year.