By DailyFX - US Dollar.Whenever we look at economic data, we use the information to extrapolate what the Federal Reserve will do with interest rates....

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However in recent weeks, the
extrapolation has become far more difficult since US data has been telling us one
thing while the Federal Reserve has been telling us another. So far, there have
been signs that the US economy is weakening and that the odds are building against
the dollar while at the same time the Federal Reserve has been telling us that
inflation has become so problematic that they have to keep on raising interest
rates. Today’s batch of economic data makes figuring out whom to believe even more
difficult. Jobless claims and the Empire State manufacturing survey both came out
strongly, but the report on net foreign purchases of US securities (also known as
the TIC report), industrial production and Philly Fed surveys all showed weakness.
Since the TIC report was the day’s most important release, the market tried to send
the dollar lower, but traders were fearful of shorting the dollar too significantly
in an environment where the Fed fund probability for a June rate hike is at 100
percent. The Treasury International capital report was extremely disappointing
today, coming out at $46.7 billion compared to a forecast of $60 billion. The
report indicated that foreign investors did not buy enough US dollar denominated
investments to plug the April trade deficit of $63.4 billion. The weakness of the
dollar and central bank reserve diversification into Euros has played a big role in
the weaker demand. The biggest selling was from the UK which is frequently thought
to include investments from the Middle East. For now, this may be written off as a
one off phenomenon, but if weak demand persists for another month, it will become a
far more pressing concern. The market currently has its focus centered on what the
Fed will do at the end of the month, but once that passes and we see the next TIC
report the following month, then another weak number will be met by a larger
reaction in the US dollar. Aside from the TIC report, the other bad news today was
the 0.1 percent drop in industrial production as well as the decline in the Philly
Fed survey from 14.4 to 13.1. Although the Philly Fed was stronger than the
market’s forecast, after seeing the jump from 12.9 to 29.0 in the Empire State
manufacturing survey, traders were looking for a stronger number to validate the
strength in the more volatile NY index. Overall, the performance in the
manufacturing sector has been lackluster at best with the Philly Fed survey
remaining at the low double digit level for the fifth consecutive month. The big
upside surprise was the jobless claims report which dipped below 300k to 295k. This
is certainly an encouraging number and is a good sign for the labor market.
However, with only 75k jobs created last month, this is only a recovery from the
worst rather than a confirmation of a continued boom.

Euro
The Euro is slightly stronger than the dollar today as Eurozone inflation numbers
come out right in line with expectations. Consumer prices rose 0.3 percent last
month, bringing the annualized pace of growth up from 2.4 percent to 2.5 percent.
The year over year rate is above the central bank’s 2 percent target and confirms
the need for the ECB to continue to raise interest rates later this year. Although
they are in no rush to raise rates at the moment, ECB President Trichet and many
Eurozone officials have often said that rates remain accommodative. Their current
stance is best summed up by the comments from ECB Bini Smaghi who said that the
future decisions on interest rates will depend on “growth and inflation.” The
central bank will continue to assess economic data and the move in commodity prices
to see if they need to raise rates again in August. Remember, even though the ECB
meets twice a month to discuss monetary policy, they usually alter rates only when
there is an accompanying press conference. The next one will not be until August
31st, which means that there will be plenty of economic data that will be released
by then for them to make a better judgment.

British Pound
The British pound continued to steadily recoup some of last week’s hefty declines,
as improving yet unsurprising economic data kept up the momentum. Retail sales for
May was the first indicator to hit the wires with solidly optimistic figures. Sales
matched estimates for a 0.5% rise over April to mark the fourth consecutive increase
for the improving sector. Oddly enough, the retail data was one more indicator that
resulted from the now familiar World Cup effect. As game time approached, purchases
of clothes and electronics spiked by 0.7 and 1.5 percent respectively. The real
question however is whether the event’s affect on the economy will amplify growth
enough as to finally bring a rate hike back onto the table for the Bank of England.
As it is, consumer spending accounts for two-thirds of the economy. The other data
sets for the day fell to the releases of the Leading and Coincident Indicator
Indexes for April. The aggregate leading index rose 0.6% for the period paced by
the strength in the benchmark FTSE equities index. Performing equally well, the
coincident indicator bumped 0.2% higher for the third straight month helped along by
strong disposable income growth and retail sales for the month.

Japanese Yen
There were no surprises from the Bank of Japan who left monetary policy unchanged
last night. The decision was unanimous and according to the central bank’s monthly
report, they stand behind their upbeat assessment on the country’s economic
recovery. Last night’s numbers support their stance with the leading economic index
bumping up from 50 percent to 54.5 percent. As far as the BoJ goes, the timing of
their eventual rate hike is still unclear and will depend on how inflation and
growth holds up. Fukui did say that the excess liquidity in the banking sector has
already been drained, which means that the next step will be to raise interest
rates. We still think that they will delay their decision until the fourth quarter
after Prime Minister Koizumi steps down from office.


Kindest Regards,

Kathy Lien
Chief Strategist
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: klien@fxcm.com

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