USD/JPY Drops as US Data Beats but Fed Still Needs to Ease

The most important piece of US data scheduled for release this week was retail sales and even though consumer spending doubled expectations, investors shrugged off the news. For our readers, this should not be a surprise because yesterday we said nothing matters more than trade tensions, recession risks and global uncertainty. Even if consumer spending soars, the Federal Reserve will still need to lower interest rates in response to the deterioration in US-China trade relations, sell-off in stocks and turn in sentiment. The US and China made it very clear today that the tariff delays in no way reflects improved trade relations. US Commerce Secretary Ross said there was no quid pro quo with China because the delays are aimed at helping US consumers alone. China in return accused President Trump of breaking the Osaka agreement and threatened to retaliate if 10% tariffs go into effect. The language used by both parties oozes of continued defensiveness and antagonism. As long as this remains the case, investors will be nervous making it difficult for currencies and equities to rally.

           

With that said, this morning's US economic reports were much better than expected. Retail sales rose 0.7% easily beating the 0.3% forecast. Excluding auto and gas purchases, spending increased the most since January. The Empire State and Philadelphia Fed surveys also beat expectations, reflecting recovery in manufacturing activity. Some reports were weaker like industrial production and jobless claims but they take a back seat to consumer spending. When the Fed last met, they did not see a hard case for additional easing but since then, the sell-off in the equity market and deterioration in US-China trade relations prompted investors to price two more quarter point rate cuts this year and now the central bank has no choice but to deliver. Like retail sales, the impact of tomorrow's housing starts, building permits and University of Michigan consumer sentiment index on currencies and equities should be shortlived.

 

USD/JPY traded as high as 106.38 on the back of retail sales but ended the day near 106. The only currency that was truly affected by the data was EUR/USD, which broke out of its range on Wednesday and extended its slide to 1.11. Aside from trade relations, USD/JPY continues to be pressured by US rates. Ten year Treasury yields dropped below 1.5% for the first time since 2016 intraday before settling slightly above that rate. The yield curve, which inverted yesterday normalized but don't be surprised if the 2-10s Treasury yield curve inverts again. These rates are so close that small changes can make a big difference in the curve shape.s

 

The US wasn't the only country to report better data. In Australia, employment beat consensus by a wide margin as jobs increased by 41K versus 14K. As our colleague Boris Schlossberg pointed out, "more importantly, fully 35k of jobs came from full-time employment indicating that growth remains robust despite headwinds from US-China tensions. However, the trend unemployment rate did rise which certainly provides RBA scope for further easing albeit at a 25bp pace." "Given the generally robust fundamental background Aussie could be ripe for short covering if the risk tensions ease"

 

In UK Retail Sales data also beat the forecast coming in at 3.3% versus 2.6% as online sales spurred spending. UK data with generally stable employment picture, growing wages and robust consumer spending is performing far better than anyone could have imagined given the threat of a no-deal Brexit and if some sort of deal can be negotiated cable could quickly rise to 1.2500 or higher but with UK leadership intent on severing ties with EU political threats outweigh the economic data for now.