IB FX View

Strength in U.S. retail sales boosts dollar – but for how long?

Tuesday September 15, 2009

In recent weeks the investment response to a distancing of the dark days of the collapse of Lehman Brothers has been a gradual pick up in risk appetite, which has lifted global equity prices to their best levels in about a year. At the same time demand for the dollar has waned as investors do away with the need to seek its safe haven qualities. Throughout this development positive economic news has detracted from the value of the dollar dragging its trade weighted index to a fresh low. Today that mechanism once again broke down, most likely temporarily, as a rather strong retail sales report saw the dollar surge on some fronts, while at the very least it made headway against others.


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Currently the euro buys $1.4578 having finished strongly on Monday at $1.4628. The euro faced its own headwinds earlier in the session when the ZEWCenter for European Economic Research released its monthly index of German investors and analysts. The expectation was for an improvement from an August reading of 56.1% to 60%. In the event investors had to be satisfied with a more modest improvement to 57.7%. It would appear that it might take more to keep the flames of euro optimism alive after the initial spark caught fire.

The big currency driver today, however, came in the shape of an extremely strong rise in the reading of U.S. retail sales for August. Sales at retailers rose 2.1% and while much of that strength is possibly spearheaded by the government’s auto stimulus program that came into effect at the end of July you can’t argue with an ex-auto rise of 1.1% compared to estimates of just 0.4%.

While this data was the catalyst for a jump in the value of the dollar against the yen to ¥91.65 from ¥90.91 on Monday and a rise against the Swiss franc to Sfr 1.0420 the dollar has faded somewhat as traders reflect on what the data may mean for risk appetite in the bigger picture.

The report also served up appetite for currencies of America’s neighbors, which both reacted well to stronger consumer spending. The Canadian dollar rallied sharply reaching 92.72 U.S. cents from 92.37 a day earlier, while the peso rose to 13.31. Mexico dumps 80% of all of its exports north of the border and so what’s good for U.S. consumption is good for Mexican trade.

Despite the current positive reaction to today’s retail sales data, other units face headwinds of their own. The dollar gained at the expense of the Aussie dollar, which fell from 86.17 U.S. cents to 85.79 cents and the British pound, which currently buys $1.6440 from $1.6572 yesterday.

Investors reacted negatively to the latest release of minutes from the Reserve Bank of Australia. In the minutes from an earlier session the committee members referred to the possibility of lifting lending rates should economic developments continue to unfold in response to a burst of strengthening economic data. Some of the Australian dollar’s strength stems from investors pursuing higher yield expectations over and above the comfortable yield cushion apparent between the 4.25% benchmark rates in Australia compared to the 0.25% in the U.S.

But today’s minutes once again thrashed out the risks associated with lifting interest rates set against current data that shows robust employment gains were recently reversed, a nine-month string of rising home loan approvals was snapped and retail sales have also fallen back. The RBA noted that the risks of contracting policy to offset high readings for inflation need to be set against the impact of choking off a recovery.

With ongoing evidence and central bankers insistence that the economic recovery remains fragile investors today threw out any chance of a rate rise throughout the remainder of 2009 from the Australians. A fall in bond yields paced today’s decline in the Aussie currency.

In Britain, two key events influenced the direction of the pound. Of lesser value in our opinion was the RICS survey indicating that for the first time in two years the balance of surveyors responding to the survey saw a net rise in the value of home prices through August. The residual Monday story from Ernst & Young’s Item Club suggesting a housing relapse as of 2010 is a far more likely scenario.

A more important influence on the pound on Tuesday was the testimony by Bank of England governor, Mervyn King to Parliament. He discussed the possibility of lowering the rate paid on bank deposits at the central bank. For some time the Bank of England has expressed concern about the volume of bank lending by the nation’s banks despite the substantial campaign to unclog the systems’ balance sheet.

The move would be a de facto reduction in interest rates and would mark a change in policy beyond what most participants have come to expect from the Bank. We’ve heard from the Fed about how it might drain liquidity from the banking system when the time comes to implement an exit strategy. Today we’re hearing confirmation that the Bank of England not only remains concerned about the health of the domestic economy, but we’re also learning that the toolbox remains at the ready to remedy ongoing problems.

Andrew Wilkinson                                                                    

Senior Market Analyst                                                               ibanalyst@interactivebrokers.com       

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