Dollar Suffers from Back and Forth in US Yields

• Dollar Suffers from Back and Forth in US Yields
• GBP: Hotter CPI Restores Expectations for Tightening
• AUD: Vulnerable to Further Losses, Watch Iron Ore
• NZD Finally Begins to Adjust to Less Hawkish RBNZ
• CAD: Gold and Oil Prices Rebound
• Behind the Resilience of EUR
• JPY: Driven Lower by Risk Aversion, No Help Expected from BoJ

Dollar Suffers from Back and Forth in US Yields

The back and forth or tug of war in U.S. yields has not been good for the dollar as the greenback traded lower against most of the major currencies. No U.S. economic data was released today but stocks sold off aggressively driving investors into the safety of U.S. Treasuries. Comments from Fed Presidents Plosser and Dudley dominated the headlines. Both of these men are voting members of the FOMC this year but they sit on completely opposite sides of the dove/hawk scale. Dudley is one of the most dovish members of the central bank and Plosser is one of the most hawkish so it is not surprising to see their comments echo their long-term views. What is interesting however is not so much where they differ but where they agree. Both Plosser and Dudley believe that the economy is improving though Dudley is disappointed by the trajectory. They both agree that the timing of a rate hike is tied to the economy and not the calendar and for this reason, no one knows exactly when the first rate hike will be. This lack of certainty should be reflected in tomorrow's FOMC minutes. Plosser believes that the Fed may need to raise rates sooner than many expect because of the significant improvement in the labor and housing markets. He even believes that the unemployment could realistically fall below 6% this year. Dudley also sees an improvement in jobs, but he feels that the recovery in housing and business investment has been weak with both sectors facing potential headwinds. He "hopes" that the central bank can raise rates next year but when rates begin to rise, the pace of tightening should be very slow. The Federal Reserve releases the minutes from their last monetary policy meeting tomorrow and given the divergence in views within the central bank we don't expect any clarity on the central bank's tightening plans. They will however remain committed to tapering bond purchases at a consistent pace for the time being. FOMC Chair Yellen and Fed Presidents Dudley, George, Kocherlakota are scheduled to speak tomorrow and of all these speeches, Yellen's will probably be the least market moving because she is only delivering a commencement speech at NYU. No comments on monetary policy are expected and she will not be taking questions from the audience. Instead we are primarily interested in the views of Kocherlakota who is a voting member of the FOMC (dove), George is a nonvoter this year. Finally we also want to mention that the low volatility environment that we mentioned yesterday is capturing the attention of more policymakers. Bank of England's Bean described the low vol as eerily reminiscent of the run-up to the financial crisis and Dudley said the unusually low volatility is a cause for concern because it may indicate complacency.

GBP: Hotter CPI Restores Expectations for Tightening

Sterling was the only high beta currency that outperformed the U.S. dollar today. Since the release of the Quarterly Inflation Report, investors have been skeptical about the central bank's pessimistic outlook on inflation and growth. They took sterling lower but not by much since last week's release. In fact with today's increase, GBP/USD is now trading higher than where it was before the Inflation Report. Today's rally was driven by hotter than expected consumer price growth that reinforced the market's expectation for greater reflation in the U.K. Consumer prices rose 0.4% in the month of April, lifting the annualized pace of growth to 1.8% from 1.6%, its highest level in 7 months and while producer price growth fell short of expectations, the market cares about CPI and not PPI. Another reason why today's release is positive for GBP/USD is because it restored expectations for tightening by the BoE. Ten year Gilt yields hit 2.61% today after dropping to a low of 2.524% the day after the Inflation Report was released. If sterling passes tomorrow's test we could see another move above 1.69. The Bank of England will release the minutes from its last monetary policy meeting at the same time as retail sales. We know that the minutes will most likely reinforce their dovishness as the meeting was held only a week before the release of the Inflation Report but retail sales are expected to rebound sharply in April. According to a survey conducted by the British Retail Consortium, the annualized pace of spending growth last month hit its highest level since April 2011.

AUD: Vulnerable to Further Losses

The Australian and New Zealand dollars were hit hard today by domestic and external factors. In Australia, more talk of a downgrade by S&P, weakness in iron ore prices and dovish comments from RBA Deputy Governor Debelle kicked off the decline in the Australian dollar. The RBA minutes did not contain anything new. Losses intensified on the back of risk aversion during the European and North American trading sessions. While the New Zealand dollar fell in sympathy with the Australian dollar, NZD also needed to adjust to the RBNZ's less hawkish monetary policy stance. At this stage both AUD and NZD are vulnerable to additional weakness unless Thursday's HSBC Flash PMI manufacturing report for China surprises to the upside in a big way because the latest decline has underlying fundamental support. Our colleague Boris Schlossberg provided more details on last night's Australian developments. He said "Although the S&P clarified its statement in overnight trade, saying that there was "less than 1-in-3 chance" that Australia would lose its AAA rating, the currency nevertheless drifted lower all night long as the mere threat of a downgrade was enough to push speculative flows out of the unit. The decline was further accelerated by comments from RBA Deputy Governor Debelle who noted that "lower capital inflows may result in a lower Australian dollar." The RBA continued to remain generally cautious on the economy, stating that, "overall growth in coming quarters was likely to be below trend given expected slower growth in exports, the decline in mining investment and the planned fiscal consolidation." The sentiment in Aussie has clearly turned negative over the past few days, especially as iron ore prices declined below $100/ton. To add salt to a wound, China's Vice Finance Minister said that global economic recovery was "extremely slow" suggesting that Chinese demand was not going to pick up any time soon."

Behind the Resilience of EUR

Of all the major currency pairs, EUR/USD and USD/CHF experienced the least amount of volatility today. Both the euro and Swiss Franc ended the day unchanged against the U.S. dollar, which is a testament to the resilience of European currencies. While it can be said that the decline in Treasury yields reduced the attractiveness of the U.S. dollar, the larger sell-off in the British pound and decline in commodity currencies reflect unique demand for euros on a day when the decline in German producer prices reinforced the central bank's concerns about low inflation. Eurozone current account numbers are scheduled for release tomorrow and expectations for this report could explain why investors have curbed their selling of euros. The region's massive current account surplus is providing underlying support for the currency. Despite the unevenness of Eurozone data and the prospect of more stimulus from the European Central Bank, money is flowing back into the Eurozone after the sovereign debt crisis now that the specific countries are beginning to recover. According to the Prime Minister of Greece, the government hopes to create 220k jobs over the next 15 years. This does not mean that EUR/USD is immune to additional weakness ahead of the June monetary policy meeting but with no major economic reports on the calendar until Thursday, the sell-off can wait.

JPY: Driven Lower by Risk Aversion, No Help Expected from BoJ

The Japanese Yen traded higher against all of the major currencies today on the back of risk aversion and a decline in U.S. yields that kept USD/JPY under pressure. The worst performing currency pairs were AUD/JPY and NZD/JPY, which were dragged down by the slide in commodity currencies. Although last night's Japanese economic reports were mostly weaker, the rise in the Nikkei overnight indicates that investors were not overly discouraged by the releases. Leading indicators were revised higher for the month of March and the all industry activity index rebounded by 1.5% after falling 1.1% the previous month. The decline in consumer spending and Machine Tool Orders overshadowed these positive reports in the month April. In Tokyo and across the nation department store sales fell more than 10% last month. Considering that sales rose 25% in March, the decline is not overly excessive. Convenience store sales also fell 2.2% year over year after growing 2.9% the previous month. This data should not instill any panic for the Bank of Japan who makes a monetary policy announcement this evening. BoJ Governor Kuroda will most likely express continued confidence in Japan's recovery and while we are still looking for another round of easing from the Japanese this year, they won't be doing so until there is a more material and consistent contraction in demand. Aside from the BoJ announcement, Japan's trade balance for the month of April will also be released and import growth is expected to slow significantly after taxes were increased. However tonight's Japanese event risks are not expected to provide much support to the Yen crosses.