Why Dollar Bulls Shrugged Off Retail Sales

Based upon the price action in the financial markets on Friday, the U.S. retail sales report failed to impress traders and investors. There was no ambiguity in the strength of the consumer spending report yet equities and bonds ended the day virtually unchanged. In the currency market, the U.S. dollar rose initially following the report but gave back its gains as equities failed to follow through. For once there was some consistent behavior in the U.S. dollar as the greenback sold off against every major currency. Interestingly enough, the biggest gainer against the dollar was the Swiss Franc which rose to the highest level in more than a month against the greenback and the highest level in more than a year against the euro. Although the decline in consumer confidence is said to have offset some of the optimism, the drop in the UMich survey was very modest. Instead, we believe that it was a classic buy the rumor, sell the news type of price action that should be temporary.

Retail sales to Pave the Way for Optimism from Fed

According to the retail sales figures, even the blizzards in the Northeast could not keep U.S. consumers out of the stores. Economists were looking for spending to fall by 0.2 percent due to weak weather and a falloff in demand for autos, but strong spending at retailers, bars and restaurants more than made up for the difference. It is a very healthy trend to see Americans eating out more and upgrading their electronics, particularly since the labor market has improved because it means that this recovery in demand should be sustainable. Excluding the lack of demand for autos, retail sales rose 0.8 percent, far much stronger than the market's 0.1 percent forecast. The pickup in consumption was not a huge surprise following strong reports from individual retailers, the International Council of Shopping Centers and the Redbook survey. Sales of electronics and appliances rose 3.7 percent, the largest rise in a year while sales at restaurants and bars rose 0.9 percent, the most since April 2008. The Federal Reserve should respond positively to the latest consumer spending and employment numbers at their monetary policy meeting next week. Given that strong job growth is also expected in March, there is a good chance the Fed will grow more optimistic and hawkish, which should keep the dollar well supported. Consumer confidence fell slightly in the month or March as Americans remain wary of the labor market.

What Does Janet Yellen Mean for the Fed?

The Federal Reserve's monetary policy announcement is the most important event on the calendar next week. Although the Fed is expected to leave interest rates unchanged at 0.25 percent, the improvements in the economy should add pressure on policymakers to unwind emergency measures. Meanwhile the details are finally starting to emerge on how President Obama plans to leverage his ability to appoint several Federal Reserve members, including Donald Kohn'S replace for Vice Chairman. At this point, it looks as though San Francisco Fed President Janet Yellen is the leading contender. Yellen is a distinguished economist and has a long track record with the Fed, making her a force to be reckoned with among policy makers. Aside from a long-standing career as a professor at Berkeley, Yellen has spent time as both an economist and a member of the Fed's Board of Governors, and served time as President Clinton's chair of the Council of Economic Advisers. Since she is currently on a three year tenure at the San Francisco Fed and her experience alone makes her a worthy candidate. However, that aside what currency traders want to know is how she will influence the future of Fed decisions. Yellen is actually a confirmed dove and has been a staunch proponent of Bernanke's near-zero interest rate policies. Yellen's stance has developed due to her unbridled criticism of the sustainability of the U.S. recovery, saying that inflation is "undesirably low" and unemployment "unacceptably high." Yellen warns that much of the recovery so far has been the result of "temporary government programs and a swing in inventory investment," items that will be unable to keep the economy afloat in the future. Accordingly, she says "it's not out of the realm of possibilities that the fed funds rate could stay at zero for the next couple of years." It is simply "not the right time to take away the punchbowl".

 EUR/USD: SHORT POSITIONS HIT NEW RECORD HIGH

The euro staged a strong rally against the U.S. dollar today as a short squeeze in the currency pair pushes it within a whisker of its one month high. According to the latest CFTC report on futures positions, after a brief cutback, net short euro positions increased by 11 percent to 74,551 contracts, the largest ever reported. The data is from Tuesday, which suggests that the rally over the past 3 trading days is most likely due to a short squeeze. However it is also important to note that euro traders were also pleased to hear that Greece has been able to pare back their deficits over the past 2 months. According to a report Greece has successfully reduced their January to February deficits by 77 percent compared to a year prior. This report comes ahead of next week's meeting of European finance ministers who are expected to endorse Greece's initiatives to reduce their deficit. EU Finance Minister Junker believes that so far, Greece has been able to "convince capital markets" but he warns that the prospect of any aid will come with serious strings attached, which may act to complicate the situation for the struggling country. There is also a possibility that finance ministers will announce a package of loans for Greece which could exacerbate the euro's gains. Meanwhile Eurozone industrial production rose 1.7 percent in January the strongest pace of growth in 20 years. The primary releases next week include the German ZEW survey and Eurozone inflation reports.

GBP/USD: SHRUGS OFF DOVISH BOE MINUTES

The British pound also rose sharply against the U.S. dollar despite dovish comments from Bank of England Monetary Policy member Dale. He said even though there are tentative signs that consumer spending is accelerating, the BoE is prepared to increase asset purchases if needed and the market should not interpret their pause in monetary policy to mean an end to loosening. Dale has long been characterized as one of the more dovish members of the BoE but we believe that his latest comments reflect the overall bias of the central bank. This is particularly important ahead of next week's BoE minutes because we expect the minutes to contain a similarly dovish tone. Employment numbers are also due for release and based upon the marginal improvements in the employment component of the PMI reports, the odds favor a deterioration in the labor market. Meanwhile last week GBP net short positions hit a record high and according to this week's numbers from the CFTC, short pound positions decreased modestly. The latest rally in the GBP/USD should have triggered additional short covering.

USD/CAD: HEADING TOWARDS PARITY

Today is a momentous day for the Canadian dollar. The currency has surged without hesitation to post its eleventh straight advance, the longest streak of gains that we have seen in the pair in more than two decades. Even more importantly, the currency is now within striking distance of parity, an event that has been more than two years in the making. Today's employment report is what set off this latest spike in the loonie. The report showed that not only did the Net Change in Employment increase at a faster rate than expected, but the unemployment rate fell to a ten month low of 8.2%. This all begs the question as to how long the BoC can hold out on taking rates higher. However, Finance Minister Jim Flaherty managed to somewhat douse these notions by holding that the economy, even though improving, is still ‘fragile'. The only thing that could encourage policy makers to retain this cautions sentiment is the high-flying loonie. However Flaherty mentioned today that a rising currency was like a ‘double-edged' sword. It can either hurt exports or benefit profitability. This marks a substantial shift in rhetoric from when policy markers held that the loonie would weigh heavily on the recovery. There is no major support in USD/CAD until parity. Canada's upcoming schedule will be highlighted by Friday's CPI and Retail Sales figures. In New Zealand, Retail Sales were a bit better, coming in at 0.8% versus 0.0% reported last month. Next week will be pretty quiet for Australia and New Zealand, with only the RBA's Monthly Minutes on tap for Tuesday.

USD/JPY: INTERVENTION IS IN PLAY AGAIN

The Japanese yen finishes up its second weekly decline on a day littered with both intervention and central bank commentary. It appears that Yukio Hatoyama's government is becoming more aware of the fact that the yen is lingering at strong levels. Hatoyama said that he needs to "take measures against such yen strength." Finance Minister Naoto Kan followed, saying that he has not forgotten that the "option of currency intervention" is still available. We have not heard much about the potential of intervention since Naoto Kan took the post as Finance Minister and said that he would prefer to see the yen a bit weaker. His comments were scaled back by a government that was not yet ready to consider the notion of currency market manipulation. Nevertheless, it looks like it is on the plate once again. Next week's BoJ meeting stands to be a crucial one as several rumors have been circulating that point to the bank taking additional easing steps. It was reported today that several anonymous bankers confirmed that they will expand the sum allocated to bank loans. The move would be in-line with consistent government prodding and declarations that the bank will fight deflation at all costs. Aside from the meeting on Tuesday, we will see the release of Consumer Confidence on Monday and the BSI Manufacturing Index on Wednesday.

USD/JPY: Currency in Play for Next 24 Hours

USD/JPY will be the currency in play for Monday. Japanese Consumer Confidence will be released at 5:00GMT or 1:00AM EST. The U.S. will release to Empire State Manufacturing survey at 12:30GMT or 8:30AM EST, followed by TIC Flows at 13:00GMT or 9:00AM EST. USD/JPY is currently fluctuating within the Range Trading Zone which we determined using Bollinger Bands. If the pair manages to break below a psychologically important 90.00 level, which is stationed right below the 20 and 100-day SMAs, expect the pair to push to this year's lows. Contrary, if USD/JPY manages to break first standard deviation at 91.10, an upward rally may emerge.