The U.S. Dollar traded sharply lower against most majors with the exception of the British Pound and the Japanese Yen.
The desire for risk helped boost the Dollar/Yen after a rise in stocks led to a renewal of the carry trade, but news that U.K. annual July consumer-price inflation slowed in June pressured the British Pound.
The USD JPY got a boost today because of the strong rally in the U.S. equity markets. A combination of friendly events fueled today’s rally which began overnight after European and Asian traders set out to satisfy their appetites for risk by supporting equities.
News that Potash Corp. rejected a buyout from BHP Billiton Ltd helped drive agricultural companies higher on the thought that other companies may be in BHP’s radar now that the original deal fell through. A report showing that retail giant Wal-Mart Stores, Inc. beat earnings estimates also helped drive investors into equities. The news regarding Wal-Mart was a sign of strong consumer spending in the wake of a dismal outlook for the economy.
At least for the time being, investor appetite for risk seems to be stronger than the desire for safety. Today’s rally was tipped off on Monday when all three major futures indices posted daily closing price reversal bottoms.
The charts suggest the USD JPY is trying to form a secondary higher bottom. The ability to regain the retracement zone at 85.55 to 85.36 is a strong sign that the Dollar/Yen may make another attempt later in the week to confirm last week’s weekly closing price reversal bottom.
Although the possibility of an intervention by the Bank of Japan and the Japanese government seems to be remote, a strong rally in the equity markets could trigger renewed interest in the carry trade especially if coupled with better than expected U.S. economic data.
The chart pattern says the Dollar/Yen is set up for a rally. It is now up to investors to show up to support the move. Without buying volume, this pattern could fade away like several have over the past few months.
The GBP USD is trying to establish support on a minor 50% price level at 1.5635. Breaking this level could trigger an acceleration to 1.5470. Needless to say, the Sterling is at a critical point on the short-term chart. In addition, there is an uptrending Gann angle at 1.5546. This angle has helped support the rally since May. Watch for a technical bounce up if this angle is tested.
Fundamentally, the British Pound took a jolt early this morning when it was reported that July inflation was lower than expected. This weakness pressured the Sterling all day. A drop in U.K. inflation is a sign that the economy is slowing. This is a concern because it could indicate the possibility of a double-dip recession, plus it comes at a time when the government is readying to apply new austerity measures and higher taxes.
The drop in the inflation rate from 3.2% to 3.1% was the third consecutive month that prices have risen more slowly. The surprise nature of this slow down highlights the difficulty the Bank of England is having in predicting how fast and far it will fall.
The BoE would like to see inflation drop to at least 2%. At this time, prices for energy, clothing and furniture are easing, but the cost of food saw its biggest monthly rise in two years. The difference in these two inflation rates partially demonstrates the power of consumer spending. It seems the consumer has a little more control on his spending for energy and other discretionary consumer goods but is not willing to cutback on his spending for necessities such as food.
Another concern for the BoE at this time is that wages are not keeping pace with overall inflation. This is another factor that could lead to a slow down in consumer spending. With housing prices already falling, the BoE does not want to deal with a serious drop off in consumer spending.
The primary reason for the sell-off in the British Pound today was most likely this growing concern because it means the BoE will have to begin another round of currency-weakening stimulus.
Tuesday’s action suggests that the risk trade is back on but that traders are willing to cherry-pick which currencies are strong and which are weak depending on the economic outlook. This scenario may produce volatility in the marketplace especially for traders who get caught up in the broad fundamentals and fail to pay attention to the details. This is one reason why following only the trade-weighted Dollar Index can get you in trouble.
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