By DailyFX – Dollar Gains Ground as Markets Stabilize; Wednesdays CPI Set to Be the Clincher for Fed Expectations

The US… … Dollar started out the week stronger against most of the majors,
as better-than-expected retail sales helped quell fears that the
subprime contagion would lead consumption growth to stall. Furthermore,
multiple central banks including the Federal Reserve, Bank of Japan,
and European Central Bank continued to inject liquidity into the money
markets, which helped to stabilize global equities. Focusing on the
economic data at hand, retail sales during the month of July rose a
stronger-than-expected 0.3 percent. Excluding autos and gas, the reading
was even more encouraging, as sales rose 0.6 percent from the month
prior. A breakdown of the data shows that clothing purchases led the
increase, which is somewhat surprising after apparel retailers such as
Abercrombie & Fitch, Gap Inc., and American Eagle Outfitters Inc. all
reported dismal same-store sales for the month. Nevertheless, it appears
that heavy discounting by stores such as Wal-Mart helped keep July's
headline reading afloat and should help alleviate some concerns that
consumer spending growth has stalled, especially after consumption
slowed dramatically in the second quarter GDP report. Markets will be
anxiously awaiting Wednesdays CPI report, as signs that price pressures
remain uncomfortably high for the Fed could lead fixed income markets to
stop pricing in a September rate cut, since the central bank is unlikely
to risk letting inflation get out of hand in order to spare the equity
markets.

Japanese Yen Weakens On Slower Economic Growth
The Japanese yen was slightly lower through overnight trade as gross
domestic product for the second quarter showed less than exemplary
results. Following a first quarter revised 3.2 percent rate of growth,
the second quarter GDP assessment was far below at a 0.5 percent
expansion. Being the last main economic indicator before policy makers
meet to decide on interest rates on August 22-23, the figure lends to a
greater likelihood of a stay on rates. This is in stark contrast to the
previously overriding sentiment in the market which previously expected
an imminent hike of 25 basis points from policy makers. Now, it seems
that speculation has shifted, and will likely weigh on the Japanese yen
in the near term, especially against carry candidates. Forecasts are
pitting a 33 percent likelihood of a rate hike versus 75 percent earlier
in the month. Going forward, policy makers will still likely remain pat
on inflationary prevention as long as consumer spending remains timid as
it has for the past year. Domestic spending continues to remain low as
consumer confidence is being dampened by rising taxes and low wages,
even as the unemployment rate dropped to a nine year low.

Reserve Bank of Australia Forecasts Higher Inflation
Although markets were privy to New Zealand food prices report, which
increased by 1.2 percent and boosted the underlying currency
incrementally in the overnight, attention was focused on the Reserve
Bank of Australia monetary assessment. In statements that helped to
support the Australian dollar briefly, monetary authorities noted that
inflationary pressures are forecasted to accelerate even further into
next year. Looking ahead, the statement notes that inflation is likely
to heighten to 3 percent at the end of the year, and subsequently remain
atop of the banks target range for much of the following year.
Subsequently, the hawkish statements come not even a week after
authorities decided to raise the benchmark overnight cash rate by 25
basis points. As a result, attention will be placed on Governor Glenn
Stevens testimony to Parliament this week. A bold tone will all but
solidify further speculation on another round of monetary tightening.
Incidentally, on the Kiwi side of things, focus will fall on tonights
retail sales figures. Expectations are for spending to pare back on
higher interest rates.

With Pound Bidders On Vacation, Sterling Drops Further
Sterling bid tone continues to remain absent from the currency markets
as it seems carry traders are paring back exposure ahead of the consumer
price index survey expected out tomorrow morning. Usually, the pair
would likely be bid up through the announcement, however, given the
global credit crunch from last week, nerves may be a little on edge.
Particularly because it also seems that expectations are for
inflationary pressures to pare back in the UK economy. Yes, it’s true.
In line with estimates forecasted by the Bank of England, it seems that
consumer price increases may be pulling back as retail demand has turned
down a bit. Suggestions of this could be seen months in advance as the
market has been privy to consumer retail spending figures that have
remained slightly under expectations. Now, this is not to say that
consumers have all but left the arena leaving economic growth to the
downside. Merely it presents room for BoE policy makers in denying the
speculative public of another rate hike past six percent. Either way,
tomorrows report will very well spell the pounds near term future
until the meeting minutes release in midweek action.

ECB Continues To Add Liquidity
With little economic data on tap for the Euro, the underlying currency
fell to the mercy of what has been evolving for the past couple of
sessions. Markets still wary of risk and exposure continued to pare
back in carry trades involving the Euro, taking the currency lower
through to support at 1.3600 briefly in New York. Exacerbating the
decline seemed to be concerns over the third allotment of cash to banks
as the ECB lent 47.4 billion euros to institutions for the third
straight day. However, to the rescue. It was IMF comments that helped
to stem losses further throughout the day as officials noted that
there-assessment of credit risk that is taking place will be
manageable. The statements are likely to shift market focus back to
rate increases in the near term as ECB officials are set to raise rates
by another 25 basis points to curb looming inflationary pressures.

DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: research@dailyfx.com

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