Can Q2 GDP Save the Dollar?

Dollar weakened across the board after a busy week. Bernanke’s semi-annual testimony and FOMC minutes came and went without much impact. Indeed, the major dollar mover was still the concern of subprime mortgage problems which sent the greenback to another record low against Euro on Friday. On the other hand, the Japanese rode on risk aversion and staged a strong rebound. The high yield currencies, including Sterling, Aussie and Kiwi, continued to strengthen against the greenback, making new decade highs. Technically speaking, dollar should be near to forming a short term bottom as its now oversold against most pairs and it could very much depend on the Q2 GDP to be released this week on whether dollar could have a meaningful recovery.

Standard & Poor’s cut ratings on European collateralized debt obligations on Friday and gauges of investor appetite for corporate bonds and loans fell. Ten year bond yields broke below the psychologically important 5% mark while Dow had a triple digit loss on Friday. Both triggered sharp selling in the dollar and buying in the Japanese yen on risk aversion.

In his semi-annual testimony, Bernanke indicated that there must be sign of sustained moderation before Fed consider dropping the tightening bias and the current benign report could be just a transitory effect. But still, underlying inflation pressure should abate in the coming months. The most notable message was that real GDP growth is expected to be between 2.25% and 2.50% this year, which is slightly below Fed’s Feb projections. Also, Bernanke argued that conditions in the subprime mortgage market have deteriorated significantly.

The FOMC minutes released last week basically echoed the themes in Bernanke’s testimony. Even though the downside risk to the economy is a bit diminished, the members are deeply concerned about housing and the potential for spillover. Also, they sounded less confident on consumer spending. On inflation, they acknowledged recent improvements in key pricing metrics but are still concerned that moderation is not convincing enough to alter the balance of risk yet. Also, the rise in headline inflation is perceived to be a threat to inflation expectations. Generally speaking, there isn’t much happenings that change the Fed’s stance yet and FOMC will like remain sideline for some considerable period of time.

On the data front, CPI stayed unchanged at 2.7% yoy in Jun, which was above consensus expectation of 2.6%. Meanwhile core CPI stayed unchanged at 2.2% too. The report suggest that inflationary pressures remain broadly under control but there is little evidence for the Fed to relax from its tightening bias yet. Even though headline PPI in US slowed more than expected to 3.3% yoy, core PPI accelerated to 1.8% vs exp of 1.6%. The data provided further support for the Fed to hold the fed funds rate steady at 5.25% in the near term considering that further moderation in inflation would likely be seen with below-potential growth and further slowdown in the housing sector.

The New York State Manufacturing Index defied critics once again in Jul and rose to 26.46, reaching a one year high, and being much better than expectation of a fall to 18.0. However, Philly Fed index dropped sharply from 18.0 to 9.2, vs expectation of 13.3. Even though building permits fell to fresh 10-year lows of 1.406m annualized rate in Jun, which is much lower than expectation of 1.48m, housing starts provides a breather as it rebounded from a downwardly revised 1.434m in May to 1.467m in Jun, which is slightly about expectation of 1.46m. TIC capital flow rose to fresh record high of $126.1b, much higher than expectation of $70b.

Germany’s ZEW was a big disappointment last week, nose-diving from 20.3 to 10.4, much worse than expectation of 21. The index peaked in May at 24.7 and has been deteriorating since then. The drop in business confidence highlighted the risk that current rise in the Euro, in particular against dollar and yen, are starting to weigh on export driven manufacturing economy and domestic demand to import.

The BoE minutes revealed that it moved the base rate upward by a quarter point to 5.75% at the conclusion of its Jul meeting, voting 6-3 to hike rates, inline with market consensus. Six members of the committee (including the Governor Mervyn King, John Gieve, Kate Barker, Tim Besley, Andrew Sentance and Paul Tucker) voted in favor of the proposition. However, the minutes suggested that there is no particular urgency, even among the hawks, to have another rate hike in the near term. Even though markets still expect another quarter point hike to 6.00% before the end of the year, the timing will likely be in Q4 and the odds for another one to 6.25% is not that high at this point. Though, the next quarterly inflation report on Aug 8 could still change this expectation.

Sterling remained generally firm during the week. There were some jitters after release of UK retail sales data which showed growth slowed more than expected in Jun. Growth in retail sales dropped form 0.4% mom to 0.2% mom, dragging yoy rate from 3.9% to 3.4%, which is a touch lower than consensus of 3.5%. However, Sterling bulls jumped in again after stronger than expected Q2 GDP report which shows 0.8% qoq, 3.0% yoy growth, comparing to expectation of 0.7% qoq, 2.9%yoy.

The Kiwi surged after higher than expected inflation data. While Q2 CPI moderated to 2.0% yoy, which is in the middle of RBNZ’s 1%-3% target range, the reading is higher than expectation of 1.8%. Also, the 1% qoq rise in CPI, which accelerated from 0.5% in Q1, signaled that another rate hike could be required from RBNZ to contain the increasing inflationary pressures in New Zealand. Both Aussie and Kiwi were supported by carry trading flows last week but the respective yen crosses was much pressured on Friday as Yen rebounded strongly on risk aversion.

The Week Ahead

The development of subprime mortgage problems in US will likely remain the focus this week which could cause much volatility in both the dollar and the yen. On the data front, the most important piece of data will be Q2 GDP, which is expected to show sharp rebound from 0.7% to 3.5%. Meanwhile, more housing data from US, including existing home sales and new home sales will be released. Durable goods orders will be featured too.

In Eurozone, Germany Ifo index will be the most anticipated data, in particular after last week’s disappointment in ZEW. Japanese data will focus on the national CPI which is expected to show the Japanese economy is not clearly out of deflation yet. Some house prices data will be released in the UK while from Switzerland, KOF leading indicator will be the focus.

RBNZ is expected to have another 25bps hike to bring the OCR to 8.25% this week after higher than expected Q2 CPI. Both Q2 PPI and CPI from Australia will be released this week. The CPI is expected to moderate further from 2.4% yoy to 1.9% and such data will reinforce the expectation that RBA is in no hurry for another hike. Canadian dollar will look into May’s retail sales data for the momentum to make another high against the dollar.


USD/JPY was bounded in choppy range trading below 122.60 resistance last week and fell sharply on Friday, reaching as low as 120.83, breaking prior low of 120.96. From a short term angle, the fall from 124.13 should still be in progress and further decline should be seen to 120.76 cluster support (38.2% retracement of 115.13 to 124.13 at 120.70). Above 122.40 resistance is needed to indicate corrective fall from 124.13 has completed. Another another decline is still in favor even in case of another recovery.

In the bigger picture, rise from 115.13 has made a top at 124.13 and turned into consolidation since then. But still, rally from 108.99, which is treated as resumption of whole up trend from 101.66, is in progress. Even in case of a deeper correction, downside is expected to be contained by 118.35/57 cluster support zone (38.2% retracement of 108.99 to 124.13 at 118.35 and 61.8% retracement of 115.13 to 124.13 at 118.57) and bring rally resumption. Next medium term upside target will be resistance zone of 100% projection of 101.65 to 121.38 from 108.99 at 128.72 and 100% projection of 108.99 to 122.17 from 115.13 at 128.31. However, break of 118.35/57 cluster support argue that rise from 108.99 has possibly completed and put 115.13 low into focus.

In the longer term picture, note that USD/JPY is staying comfortably above the long term falling trend line (147.68 to 135.20). Multi-year consolidation pattern that started from 147.60 should have already completed. But, whether current rise from 101.65 represents the resumption of whole up trend from 79.75 remains to be seen. Note that above mentioned medium term projection target of 100% projection of 108.99 to 122.17 from 115.13 at 128.31 and 100% projection of 101.65 to 121.38 from 108.99 at 128.72 are in proximity to 78.6% of 135.20 to 101.65 at 127.95. This cluster resistance zone will be important to determine the long term trend.

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