Further 'Mild' Dollar Gains Forecast this Week, Retail Sales Provide Impetus, Watch Inflation Data Tuesday

Retail sales data pushes USD higher

The US dollar's May uptrend remains intact and we hear markets should expect further advances to be delivered over coming days, however the advances should become more limited in nature.

  • US retail sales beat expectations, provide fundamental justification for further USD gains
  • Mild USD gains seen this week as markets still positioned against dollar

The US dollar exchange rate complex advanced for a second consecutive week and there signs that the third week of the month of May should provide further advances.

Aiding a USD recovery is a market the remains 'short' on the currency - i.e the market continues to bet against the currency ensuring there is dollar upside to be had as more traders exit this stance.

To gauge the net USD position, analyst Stephen Gallo at BMO Capital Markets looks at the net position of the aggregate of {AUD,EUR,CAD,CHF,GBP,JPY,NZD}.

That position stands at a net USD short of 3.4bn.

This marks the third straight week of an aggregate net USD short and the biggest position on that side since May 2014.

"The aforementioned IMM positioning data corroborates what we have observed from the USD’s behavior. The USD has begun to rally more consistently and powerfully on risk-off days than in 2015 and earlier in 2016 because the market is short-USD," says Gallo.

"In a market with stale themes and behind-the-curve participants, the natural inclination is to bet against positioning."

As a consequence, the USD has been "melting up" over the past two weeks and BMO Capital think it can continue to do so, although only about another 1.0 to 1.5%.

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Retail Sales Prompt Dollar Advance

The dollar shot higher on Friday on news US retail sales grew a healthy 0.8% in April, ahead of the 0.5% forecast by analysts and an improvement on the previous months -0.3% contraction.

Strength was spread evenly across the monitored sectors, with a 0.8% gain in sales excluding the auto sector and a 0.9% jump in ‘control’ sales (retail sales ex-autos, gas stations, and building material stores) marking the strongest increase for that key measure since March 2014.

"The stronger than expected rise in April retail sales was consistent with our view that consumer spending growth will rebound in the second quarter of 2016 after slowing to a 1.9% pace in the first quarter that looked understated to us relative to the solid labour force backdrop and rising household incomes in the quarter,” says Nathan Janzen, Senior Economist at RBC Economics.

The data had an immediate impact on the dollar which shot higher across the board and in the absence of a calamity looks set to end the week higher than when it opened - making this the second consecutive week of gains and confirming the recovery is becoming increasingly entrenched.

The pound to dollar exchange rate is under particular pressure and is seen lower at 1.4365 having opened the week at 1.4429 and recorded a high of 1.4530 following the Bank of England’s Inflation Report.

US Federal Reserve Tipped to Raise Rates

The prospect of a June interest rate in the US will have risen markedly after the strong retail sales figures.

Focus has turned back to US interest rates once more and this week we have heard a number of pro-hike comments made by voting members.

Mester: "I support a gradual adjustment of short-term interest rates toward a more normal level, but I view the current level as too low for today's economic conditions. The economy is at or near full employment and inflation is close to the FOMC's target of 2%, yet short-term interest rates remain near historic lows."

Rosengren: “The market remains too pessimistic about the fundamental strength of the US economy, and the likelihood of removing monetary accommodation is higher than is currently priced into financial markets based on current data.”

George: “Moving rates to a more normal level and at a gradual pace is necessary to minimise distortions in the economy that can build over many years when rates are held so low.”

Ahead of the publication of the minutes of the April FOMC meeting next week it could be argued that the comments from hawks George and Mester were far from surprising, this comes as the former detailed that rates are too low for current economic conditions.

However, analyst have jumped onto comments made by noted dove Rosengren as representing a notable shift in the balance amongst voters.

The Boston Federal Reserve President reminded the market that it “remains too pessimistic about the fundamental strength of the U.S. economy, and the likelihood of removing monetary accommodation is higher than is currently priced into financial markets based on current data.”

“Expect the USD to remain supported via a re-pricing of rate expectations; note the USD is up against all the majors month to date,” says analyst Jeremy Stretch at CIBC.

All Eyes Turn to Inflation Data Release

Further confirmation for a pro-USD rate rise will be sought on Tuesday the 16th when inflation data are released.

Higher energy prices probably pushed up the year-on-year inflation rate two ticks to 1.1%.

But the annual core CPI inflation rate could fall one tick to 2.1%.  

Inflation numbers could deliver an upside surprise in the wake of the release of Producer Price Index figures on Friday the 13th.

PPI rose 0.2% m/m in March, above consensus (0.1%) expectations.

Excluding food, energy, and trade, PPI inflation increased a very robust 0.9% on the month. On a y/y basis, headline PPI was rose 0.1%, a modest improvement from the March reading.

The goods component of PPI also rose 0.2% m/m; excluding food and energy, goods prices rose 0.3% m/m.

Services prices increased 0.1% m/m, pulling the y/y rate down to 1.1% y/y.

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