Dollar Slips as US Data Highlights Fed's Challenges

• Dollar Slips as US Data Highlights Fed's Challenges
• GBP: Will Carney Flip Flap Again?
• AUD: Erases Post Chinese PMI Gains
• CAD: Price of Oil Slips Below $106
• NZD: RBNZ Deputy Gov Says House Price Inflation Moderating
• JPY: Investors Unimpressed by Abe's Third Arrow

Dollar Slips as US Data Highlights Fed's Challenges

Today's U.S. economic reports illustrate the challenges that the Federal Reserve faces. Growth is obviously subpar with GDP contracting 2.9% in the fourth quarter and durable goods falling 1.0%.  This contraction was much deeper than economists anticipated and was made worse by the steep downward revision to personal consumption.  When these numbers were first released, the dollar fell sharply against all of the major currencies and 10 year Treasury yields dropped below 2.53%. However the sell-off in the dollar was limited by the fact that U.S. GDP growth is backwards looking and the hope that the Fed accounted for the weak release in last week's GDP revisions.  The second quarter is also shaping up to be stronger with economic activity activity hitting a 5 year high according to Markit Economics' report.  Between the rise in service and manufacturing activity, GDP growth is set for a strong rebound in Q2.  Unfortunately the Federal Reserve will want to see how the economy performs in Q3 before getting excited about the recovery.  So at the end of the day, the latest economic reports simply validate the central bank's steady and conservative monetary policy stance.  For the dollar and the major currency pairs, this means that ranges will remain intact.  Even if Thursday's jobless claims, personal income and spending reports surprise to the downside, the sell-off in USD/JPY should be limited to 101.00. 

GBP: Will Carney Flip Flap Again?

Unlike other high beta currencies, the British pound failed to benefit from the improvement in risk appetite or dollar weakness.  Tuesday's less dovish comments from Bank of England Governor Carney left investors confused on how serious the central bank really is about raising interest rates.  Earlier this month, the market was convinced that rates could rise as early as this year but now, they are uncertain about whether the central bank simply wanted to align market expectations with data.   The head of the central bank has one last opportunity this week to clarify his views.  The BoE releases its Financial Stability report on Thursday in which they are expected to publish recommendations to cool the housing market. If he fails to revive expectations for tightening, sterling would be hit with a deeper slide.  In order for GBP/USD to take out its 5.5 year high, we need Carney to make it clear that he along with many of his counterparts at the MPC believe that rates could rise as early as this year.   Given the extreme amount of long sterling positions in the market, anything short of unambiguously hawkish comments should trigger profit taking on long GBP/USD trades.  From today's consolidative price action, it is clear that investors are waiting for Thursday's speech.  If Carney fails to deliver, GBP/USD could make a run for 1.69.

EUR: German Consumer Confidence Hits 7 Year Highs

EUR/USD extended its gains today on the back of dollar weakness and stronger economic data.  Thanks to the recent rate cut and stimulus measures from the European Central Bank, German consumer confidence rose to its highest level since 2006.  According to GfK, the agency that releases the survey, "The ECB's policies had a strong negative impact on the propensity to save in Germany, supporting instead consumers' willingness to buy."  Rising wages and a stable labor market also helped to boost the mood in the Eurozone's largest economy.  However the good news won't affect the ECB's dovish bias because the gap between German and French growth continues to widen.  While German consumers grew more optimistic, manufacturing and business confidence in France weakened. Since the ECB meeting, we have said that EUR/USD should hold 1.35 and now it is clear that without a renewed resolve to ease, the euro will not break this support level in the near term.  According to the latest comments from ECB officials, some policymakers are reluctant to keep monetary policy too easy.  ECB member Knot said the central bank is aware of the risks from monetary easing, Linde said asset purchases could come with complications and Weidmann said the central bank shouldn't intervene too much in market processes and that rates shouldn't stay low for longer than necessary.  These policymakers certainly do not sound like they are eager to push the go button on additional stimulus.  At the same time, we believe the EUR/USD rally will be limited to 1.3700.

USD/CAD Extends Lower on Rally in Oil

After losing ground to the greenback on Tuesday, the New Zealand, Australian and Canadian dollars came back strongly. NZD/USD led the gains but President Obama's decision to loosen its four-decade ban on oil exports was the focus for commodity currencies.  The Commerce Department gave two U.S. oil companies the right to export light crude oil, which is small start that commodity traders interpreted as positive for oil prices and in turn the Canadian dollar. In the long run however, U.S. oil exports should hurt and not help the CAD because it could reduce demand for Canadian oil but given the small allowance from the Obama Administration, the overall impact should be nominal.  The same is true for the U.S. dollar, in order for oil exports to help the greenback, it needs to narrow the current account deficit but unfortunately the deficit is widening because of non-oil demand.  Having closed at the day's low, we expect further losses in USD/CAD. There was no economic data from Australia or New Zealand but renewed speculation that the RBNZ will raise rates in July provided a boost to NZD/USD. Australian job vacancies are scheduled for release tomorrow followed by Canadian average weekly earnings.

JPY: Inflation Moving in the Right Direction

The Japanese Yen traded lower against all of the major currencies today with the exception of the British pound and U.S. dollar. Producer prices for the service sector was the only piece of data released from Japan overnight and according to the report, price pressures rose at their fastest pace since 1991 in May.  Although part of the rise can be attributed to the sales tax in April, excluding the impact of the tax, prices still increased by 0.9%.  Thanks to the Bank of Japan's efforts, inflation is moving in the right direction.   However even with the positive data, risk appetite has been the primary driver of Yen flows.  Between the rebound in U.S. equities and the rally in high beta currencies, we have seen most of the Yen crosses trade higher.  The best performer was NZD/JPY, which is not surprising given the strength of NZD/USD.  Japan will be releasing a lot of data Thursday evening / Friday morning local time but between now and then, only the Ministry of Finance's portfolio report is scheduled for release.  Since we believe that the downside in USD/JPY is limited, Yen traders should keep their eyes on risk appetite.