By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The strongest increase in retail sales in more than a year drove the U.S. dollar sharply higher against all of the major currencies, Friday, but the gains did not last. Consumer spending rose 1.3% in April. Economists were only looking for a 0.8% rise. Excluding autos and gas, retail sales also increased 0.6%, which was only half of total spending growth but still a very healthy rebound that gives investors hope that the U.S. economy isn’t spiraling lower. The dollar shot higher on the back of the report but the gains fizzled quickly as investors realized that one good release won’t change anyone’s mind about leaving interest rates unchanged in June. Producer prices rose less than expected last month while consumer confidence hit 11-month highs.
Looking ahead, there are a flurry of U.S. economic reports scheduled for release next week including the Empire State survey, the Philadelphia Fed index, housing starts, building permits, consumer prices and existing home sales reports. However the main focus will be the April FOMC minutes. The tone of last week’s meeting was slightly more upbeat -- the Fed liked how the labor market has been performing but they no longer view economic activity as expanding at a moderate pace. They also acknowledged that spending softened but are optimistic that it will improve with real income growth rising and consumer sentiment rebounding. Yet their comments about inflation remaining low and inflation expectations being little changed -- along with their acknowledgement of slower domestic growth -- signals that rates will remain steady in June. Also, the absence of the balance of risks statement from the 3rd consecutive FOMC statement indicated that there is still significant division within the ranks making any majority decision on moving rates difficult.
USD/JPY traders will also be watching next week’s Q1 GDP report from Japan. Growth is expected to turn positive after a negative quarter and given the market’s focus on the timing of BoJ easing, stronger or weaker growth could have an unusually significant impact on the yen. While Japan’s economy is generally weak, improvements in trade and retail sales in the first 3 months of the year should have helped to lift first-quarter growth.
Weaker-than-expected first-quarter GDP growth also pressured the euro. Although the German economy expanded at a healthy 0.7% pace in Q1, growth in the Eurozone was revised lower to 0.5% from 0.6%. Greece was a laggard along with Belgium -- larger countries such as France and Italy grew at a faster pace while Spain maintained its 0.8% expansion. While disappointing, this was still the fastest pace of quarterly growth in a year and that should be enough to prevent a deeper slide in EUR/USD. Looking ahead, the account of the most recent ECB meeting (basically the minutes), Eurozone trade, CPI and current account numbers are scheduled for release next week. Most of these economic reports are expected to be stronger but the ECB report should contain a cautious tone that could hamper gains in the currency.
Sterling will also be in play with consumer prices, employment and retail sales scheduled for release. These are some of the most important U.K. economic reports on the calendar and could finally take EUR/GBP and GBP/USD out of their recent range. Unfortunately these numbers are likely to confirm the environment that the Bank of England described this week, which is one of rising inflation and slower growth. According to recent PMI reports, all of which decelerated, deflationary pressures eased in April but job losses accelerated significantly. Consumer spending is also expected to remain subdued with a continued drop in sales reported by the British Retail Consortium.
Meanwhile, lower iron ore prices continued to drive the Australian dollar lower. The price of one of Australia’s most important commodities has fallen 23% over the past month, validating and now increasing the pressure on the RBA to ease again. In Australia, some economists are talking about another 75bp reduction but we think 25bp is more likely. Either way, the currency is vulnerable to additional weakness on the back of next week’s Reserve Bank of Australia minutes. When the central bank last met, they felt inflation was such a problem that they needed to act immediately. This urgency is likely to be echoed in Monday night’s report.
The New Zealand dollar also came under selling pressure after weaker-than-expected retail sales growth in the first quarter. Consumer spending grew 0.8% in the first few months of the year, which was lower than the downwardly revised 1.1% reading for Q4. While New Zealand data hasn’t been great, recent comments from NZ policymakers have reduced the chance of near-term easing. Central Bank Governor Wheeler expressed concerns about house prices in Auckland while Finance Minister English promised to bring forward spending from 2017 to 2016, reducing the need for monetary stimulus. As such we expect NZD to continue to outperform AUD with the currency ultimately headed for 1.0600 and lower.
After falling for 3 straight days, USD/CAD finally rebounded against the U.S. dollar. Oil prices struggled to extend their gains Friday as investors realize that the IEA’s forecasts for supply and demand changes nothing about the underlying issues with supply and demand. Given the recent trend of global economic data, we are not sure if this forecast is accurate, particularly since Iran will continue to flood the market with supply. Early this week, Saudi Arabia said it plans to increase production. Meanwhile the supply disruptions caused by the wildfires in Canada and attacks in Nigeria are expected to be short-lived. Oil is headed lower and USD/CAD is headed higher with the commodity likely to drive the currency in the first half of next week. It won’t be until Friday that Canadian dollar traders turn their focus to the economy with retail sales and consumer prices scheduled for release. Spending is expected to fall sharply and inflation is expected to slow -- 2 factors that would confirm our positive outlook for USD/CAD.