Dollar Remains Weak Ahead of FOMC, Housing Data Fails to Help

As the Federal Reserve begins their two day monetary policy meeting, the U.S. dollar is trading lower against all of the major currencies. The dollar's weakness is due in large part to the warning by Fitch that the U.S. debt rating could be put on negative watch if the U.S. debt ceiling is not increased by August 2nd. Fitch even went one step further than they did two weeks ago by adding that the U.S.'could be moved to restricted default if the Aug 15th coupon payment is not met.  Having received significant criticism during the financial crisis for being behind the curve, rating agencies are on the defensive issuing downgrade warnings when the chance of the U.S. actually missing a coupon payment is slim. With that in mind, the impact of Fitch's warning was minimal because they made the same threat 2 weeks ago. Also, Moody’s and Standard & Poor’s downgraded their outlook on U.S. debt on June 2 and April 18, respectively so Fitch’s warning is not as big of deal because they only issued a warning while S&P and Moody's actually downgraded the outlook for U.S. debt. Fitch is still trailing behind other rating agencies and the market is fully aware of that.

Existing Home Sales

Existing home sales was the only piece of U.S. data on the calendar today and according to the latest report, sales declined 3.8 percent in May. While the drop in existing home sales was smaller than investors had anticipated, the large downard revision to the prior month's report and the drop to a 6 month low does not bode well for the U.S. economy.  As long as home sales are below 5 million, the housing market is in the trouble. The only real silver lining in the housing data was the rise in home prices - every region in the country reported a rise in the average price of a home sold which means one of two things - either sellers are becoming confident about the outlook for the housing market or they are willing to hold out longer for a higher price

QE Coming to An End

By the end of this month, the Federal Reserve will have completed its asset purchase program, bringing its second round of Quantitative Easing to an end.  Last month, Bernanke laid out the Fed's plans once QE is completed and he will most likely reassure investors tomorrow that the game plan of reinvesting principal payments on maturing securities remains in place.  The end of QE2 could actually help the dollar.  When the first round of Quantitative Easing ended around April 2010,  the dollar index rose 10 percent between April and mid June. Over the next few months it trended lower as investors considered the possibility of QE2.  Since QE3 is not likely this time around, the end of QE2 could spark a dollar rally based on the prospect of higher yields and less concerns about inflation or currency debasement. We'll be publishing our FOMC outlook later this afternoon so stayed tuned!

Canadian Retail Sales Fall Short

Meanwhile Canadian retail sales fell short of expectations in the month of April. Not only was the prior month's report revised downwards but consumer spending rose only 0.3 percent. The real disappointment however was in retail sales less autos which was flat against a forecast for 0.6 percent growth.  After a very weak March, investors were hoping for a sizeable rebound in April, but a weak labor market and slow global growth prevented any meaningful pickup in consumer spending.  The latest retail sales number will make the Bank of Canada weary of tightening monetary policy prematurely.  The BoC is in the same position as many other central - they have the flexibility to sit and wait until the economic outlook for Canada improves and for the uncertainty to Europe which also affects Canadian markets to subside. The Canadian dollar managed to shrug off the weaker retail sales report easily due thank to a sharp 1.0 percent rise in leading indicators.  The retail sales number was from 2 months ago but leading indicators reflects economic activity last month, giving the BoC hope that things are not all bad.