Behind the Rally in the USD and Slide in NZD

• Behind the Rally in the Dollar
• New Zealand Dollar Hit Hard by Plunge in Dairy Prices
• AUD: No Changes from RBA
• CAD: Selling Off Hard Ahead of Trade Data
• EUR Drops to Fresh 8 Month Lows
• Sterling: Refuses to Rally Despite Positive Data
• BoJ Worried About Exports

Behind the Rally in the Dollar

The U.S. dollar traded higher against most of the major currencies today on the back of better than expected U.S. data and risk aversion.  Stronger U.S. economic reports is normally positive for stocks but Russia's plans to respond to U.S. and European Sanctions and weak earnings prevented stocks from rising on the back of faster growth in the service sector and the uptick in factory orders.  While we felt the ISM non-manufacturing report would have less impact on the dollar this month than in past years because of the early release of non-farm payrolls, we did not expect it to provide absolutely no support to stocks or Treasury yields because at the end of the day, the U.S. is a services based economy, making today's report exceptional important.  We could say that the dollar was the only instrument that responded logically but looking beneath the hood, the majority of the greenback's gains occurred before the ISM report.  In fact USD/JPY dropped to 102.55 at the end of the North American trading session from a high of 102.92 post ISM.  We believe it would be more appropriate to attribute the rise in the dollar to the risk aversion that began in Europe.  Some investors are looking at the improvements in U.S. data as reason for the Fed to raise interest rates sooner but without a steady improvement in the labor market and wage growth, they will avoid tightening monetary policy prematurely. With no major U.S. economic reports scheduled for release this week aside from ISM (trade is not that market moving), we still believe that relative value plays will provide the greatest opportunities but risk appetite will be important as well. The dollar continues to trade in a tight range against the Yen but weakness abroad could boost the greenback's gains against the other currencies.

New Zealand Dollar Hit Hard by Plunge in Dairy Prices

The worst performing currency today was the New Zealand dollar. A sharp decline in dairy prices, risk aversion and demand for the greenback drove NZD/USD to its lowest levels in 7 weeks. If tonight's employment report surprises to the downside, the currency pair could hit a 5 month low below 84 cents.  Falling dairy prices is a serious problem for New Zealand.  Prices dropped 8.4% at today's Global Dairy Trade auction, which adds to the 8.9% decline at the last auction. Since February, prices are down 41%, which is disastrous for terms of trade because dairy accounts for approximately a third of New Zealand's exports by value.  There's a good chance Fonterra will lower its payout further this year and all of this has a direct impact on the terms of trade, GDP growth and the Reserve Bank's pace of tightening.  At this stage, the RBNZ has very little reason to raise interest rates again this year.  The Canadian and Australian dollars also fell sharply today.  No major economic reports were released from Canada but oil prices declined and some traders are positioning for a weaker trade report tomorrow.  The Australian dollar on the other hand shrugged off stronger service sector activity and a narrower trade deficit.  The Reserve Bank kept interest rates on hold and left their monetary policy statement virtually unchanged. The central bank has now kept rates steady for a year, the longest period since 2006.  With the Australian dollar still viewed as too high by historical standards and the RBA feeling that it would "probably be some time yet before unemployment declines consistently," rates will most likely remain unchanged for the rest of the year. 

EUR Drops to Fresh 8 Month Lows

The euro dropped to a fresh 8 month low against the U.S. dollar on the back of weaker economic data and a broad based dollar rally.  Economic activity in the Eurozone was revised lower for the month July due to slower growth in the service sector.  Improvements in Spain were offset by weakness in Germany and Italy.  Consumer spending growth also fell short of expectations but the data was not terrible considering the upward revision in May and the sharp rise in annualized spending growth.  However based on the recent losses in the euro, it appears that investors are positioning for more caution from the European Central Bank.  Recent economic data certainly doesn't give them any reason to be happy with the performance of the economy.  This morning, there was talk that ECB President Draghi will be meeting with EU Commission Juncker tomorrow.  If they do meet, the discussion should be focused on fiscal and monetary reform along with other methods of stimulating the region's economy.  German factory orders are scheduled for release but the impact on the euro should be limited. 

Sterling: Refuses to Rally Despite Positive Data

Having been burned by the Bank of England who retreated on its bias for an earlier rate hike, sterling traders refused to buy the currency despite stronger than expected economic data.  Service sector activity grew at its fastest pace in 8 months with the PMI index rising to 59.1 from 57.7. This more than offset the drop in the manufacturing PMI index and helped to lift the Composite PMI index to 58.8 from 57.9.  The data shows that the service sector is providing enough support for the economy and when combined with the relatively healthy construction sector PMI index, keeps the possibility of earlier tightening in play. In fact, the details of the PMI survey showed an increase in salaries.  The BoE made it clear that tightening will be predicated on wage growth and according to the PMIs, there's positive movement on that front.  Nonetheless the Bank of England is widely expected to leave interest rates unchanged on Thursday and we won't know if they have grown any more willing to raise rates until two weeks later when the minutes are released.  From now until then, we have more manufacturing related reports that should remind us of areas of weakness in the U.K. economy and perhaps this is one of the main reasons why sterling shrugged off today's reports.  Of course it also didn't help that Moody's downgraded its outlook for the U.K. banking sector from stable to negative based on new rules that prevent taxpayer bailouts. Considering that no major U.K. banks are at risk of needing a bailout, it does not pose an imminent threat to the economy or the banking sector.  U.K. industrial production numbers are scheduled for release tomorrow along with Halifax house prices, the BRC shop price index and NIESR's GDP estimate for the month of July.

BoJ Worried About Exports

The Japanese Yen strengthened all of the major currencies with the exception of the British pound.  The 1% sell-off in the Nikkei last night kept most of the Yen pairs under pressure and the decline in the Dow during the North American trading session added to the pain.  USD/JPY received support from stronger U.S. data, which would normally be positive for the Yen crosses but the demand for dollars led to a larger decline in high beta currencies that overshadowed the positive contribution from USD/JPY.   While service sector activity expanded at a faster pace in July, leading to a general uptick in economic activity, the slowdown in manufacturing activity reported last week still have investors worried.  In fact the Bank of Japan expressed specific concern about exports and output last night according to insiders.  They are said to be mulling the possibility of downgrading their assessment of exports and output given increasing signs of weakness in the economy following the sales tax increase.  If they choose to do so, it could renew expectations for BoJ easing which would send the Yen lower.