Dollar Turns Higher after Retail Sales Rise and as Fed Rate Cut Forecasts Land on Scrapheap

- USD turns higher after December retail sales gains.

- After U.S. consumer seen in fine fettle into year-end.

- Suspension of China hostilities to aid global economy.

- But a global growth rebound is still an open question.

- Existing tariffs to remain in place, tensions set to linger.

- As Fed outlook improves, rate cut forecasts abandoned.

Image © Yevgen Belich, Adobe Images. Shanghai Cityscape.

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The Dollar turned higher late Thursday after retail sales figures surpassed expectations for the month of December, helping to reverse earlier losses and questioning the widely-held belief the economy slowed in the final quarter. 

Total retail sales rose by a respectable 0.3% in December, although that particular number was unchanged from the prior month and was also well anticipated by the consensus. Core retail sales on the other hand, rose by a sharp 0.7%, up from 0.1% in November and ahead of the 0.5% consensus.

Core retail numbers are given more attention by the market because they exclude car sales from the data due to the distorting impact their large price tags can have on underlying trends. The big move in December’s core number explains the big turnaround in the Dollar, which had ceded ground to many other majors ahead of the release but was quoted higher relative to all except the Pound and Kiwi in the wake of it. 

“The dollar snapped back after a U.S. data depicted the world’s biggest economy firing on more cylinders than most global peers,” says Joe Manimbo, an analyst at Western Union. “The data allayed worries about a marked slowdown in fourth quarter growth from the third quarter’s 2.1% pace.”

Above: Pound-to-Dollar rate shown at daily intervals.

Retail sales are a substantial component of the consumer spending that underpins the economy, which accelerated in the third quarter when GDP growth rose from 2% to 2.1%. Strong December spending could mean the economy slowed less than markets anticipate for the final quarter, which might impact investors' views on the Federal Reserve (Fed) interest rate outlook. 

Thursday’s figures could also keep alive the possibility the economy did not slow at all into year-end. After all, markets had expected a sharp slowdown in the third quarter and the Bureau of Economic Analysis originally said that growth did falter, before eventually revising its initial 1.9% estimate up to 2.1% back in November. Economists beg to differ with that interpretation though. 

“The control group also beat expectations in December. That December rebound for the control group, however, came off the back of a downwardly revised prior month (now -0.1% from +0.1%). That left sales on that measure actually down slightly in Q4 vs Q3, and is a key reason why we have consumer spending decelerating in the final quarter of last year,” says Andrew Grantham, an economist at CIBC Capital Markets

Above: Dollar Index shown at daily intervals.

Investors were busy selling the Dollar in exchange for just about any other currency ahead of the retail report in response to what is an improved outlook for the global economy now the long-elusive U.S.-China deal has finally been signed. The idea behind those sales was that a cessation of trade hostilities will enable the global economy to recover, providing investors with a glimpse of a world where U.S. interest rates no longer stand so tall above most of their developed world alternatives. 

However, much about the outlook depends on whether growth does in fact recover outside of the U.S. and also on the actual performance of the world’s largest economy in the quarters ahead. Punitive U.S. tariffs are set to remain on China’s exports for at least the bulk of 2020, with all that might entail for everybody else, even after Wednesday’s trade deal was signed. Some of the tariff percentages will be reduced, however, although it's far from certain that this will be enough for the global economy to recover and even less so that any possible rebound will be sufficient to get the market selling the Dollar again.

“Downside risks for U.S. growth have faded, helped by the Phase One trade deal and an easing in financial conditions, helping the case for growth to keep showing resilience and for the Fed to stay on hold. We advise against extrapolating indefinitely, however. We still expect the next Fed move to be easing, albeit not until year-end. We now forecast 25bp easings in December 2020 and March 2021 instead of March and April of 2020,” says Jim O’Sullivan, chief U.S. macro strategist at TD Securities

Above: Euro-to-Dollar rate shown at daily intervals.

Pricing in the overnight-index-swap market is implying that on December 16 the midpoint of the 25 basis point wide Fed Funds rate will sit at 1.31% when it's currently between 1.5% and 1.75%. That pricing suggests investors see one 2020 Fed rate cut as a certainty and also some scope for a second cut although the implied midpoint has risen from 1.10% in early October - before the U.S.-China deal was first announced - which explains part of the Dollar’s performance since then. 

Market as well as economists and strategists have all to some extent pared back their expectations for Federal Reserve rate cuts this year due to not only the trade situation and seemingly better performance of the economy, but also due to consistent messaging from Fed Chairman Jerome Powell and his colleagues. And they could yet be pared back even further, which might aid the Dollar if the anticipated growth rebound does not materialise outside of the U.S.

Powell said in December that so long as U.S. growth is “sustained”, the jobs market remains “strong” and inflation is “near the symmetric 2 percent objective" the current 1.75% level of interest rates would "remain appropriate”. And many of his Federal Open Market Committee colleagues have since echoed those sentiments. The Fed cut rates three times in 2019.

“The US/China trade war is about restoring balance and clean reciprocity to the relationship, and the direct impact on economic growth from the agreement is limited at best. The USD still needs the US growth dynamic to continue to move in its favor, and while downside in the currency is limited, FX investors are more likely to err on the side of caution for the time being,” says Stephen Gallo, European head of FX strategy at BMO Capital Markets.

 

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