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Forex - Canadian Dollar Hits 29 Year High on Strong Retail Sales

DailyFX Fundamentals 05-18-07

By Kathy Lien, Chief Strategist of

• Dollar Weakens as Chinese Yuan Revaluation Reduces the Need for Buying
• British Pound: Sharp Fall in Retail Sales Leads to Sharp Fall in Rate Hike ExpectationsCanadian Dollar Hits 29 Year High on Strong Retail Sales

Dollar Weakens as Chinese Yuan Revaluation Reduces the Need for Buying
The world turned its focus to the currency market today as China made its second most significant revaluation move in two years. The central bank of China announced this morning that they were widening the trading band for the Yuan, increasing reserve requirements and raising interest rates. The last time China revalued its currency was in July 2005 and just as that move came a week after the US imposed a timetable for Chinese revaluation, this move comes in the midst of the G8 meeting and a week before a Chinese delegation arrives in the US for talks with Treasury Secretary Paulson. This politically well timed move is characteristic of most moves made by China. As a proxy for Asian strength or weakness, the latest announcement has sent the Japanese Yen rallying. It has also sent the US dollar lower since a wider trading band means that China will need to buy less US dollars. The stock markets around the world have yet to react and they may be looking to the Chinese market for clues. The announcement was made after the close of trading in Shanghai, which means that we will need to wait until Sunday night to see how Chinese investors really feel about this triple blow. In the meantime, the US dollar still ends the week stronger against most of the major currencies. The more promising outlook on the labor market has helped to offset the burden of higher gasoline prices and concerns about housing. The US economic calendar next week is light especially in the front end of the week. The only potentially market moving data are durable goods, new home sales and existing home sales on Thursday and Friday.

Euro: Looking for Clues to What the ECB May do Beyond June
The Euro is slightly stronger today despite disappointing economic data. German producer prices increased by a meager 0.1 percent in the month of April compared to the market’s 0.4 percent forecast. The softer inflation number is another piece of evidence that the weakness in the US dollar and the strength of the Euro could discourage the European Central Bank from lifting interest rates beyond June. The reaction in the Euro was relatively muted because the June rate hike has already been fully priced into the market while the PPI number does little to clarify whether the ECB will or will not move again after that. As Trichet indicated last month, they will decide what to do after June in June. Their decision is data dependent and there are a number of key European data that could help shed more light on the monetary policy outlook next week. We are expecting the release of the German ZEW survey, the trade balance, industrial orders and the IFO survey of business sentiment. The market is looking for these indexes to hold steady thanks to the strong growth. We remain skeptical as the strong Euro and prospect of a rate hike could at least make analysts more pessimistic. Meanwhile Switzerland also has a busy economic calendar next week that could lead to some interesting movements in the Swiss Franc. They will be releasing producer prices, employment, the trade balance and KoF leading indicators.

British Pound: Sharp Fall in Retail Sales Leads to Sharp Fall in Rate Hike Expectations
The British pound staged an incredibly impressive intraday recovery. Having sold off to a fresh one month low after the disappointing retail sales report, the pound rebounded to end the day unchanged as the US dollar began slipping after the Chinese announcement. This should not underestimate the fact that UK consumer spending was very weak in the month of April however. Originally expected to rise by 0.6 percent, retail sales fell for the first time in 3 months by 0.1 percent. There was an upward revision to the March data, but not enough to offset the decline that drove the annualized pace of spending from 5.0 percent down to 4.2 percent. This number does serious damage to the expectations for future rate hikes and goes a long way to explaining why the Bank of England may have chosen not notch up their degree of hawkishness after the last rate decision. With inflation and spending slowing, the central bank is in no rush to tighten monetary policy. Some traders may be waiting for this bias to be confirmed in next week’s release of the BoE minutes before taking the GBP/USD much lower. Aside from the minutes, the UK will also be releasing the CBI industrial trends survey, housing and lending data.

Yen Rises on Pressure for Action by Japan
The revaluation announcement by China has led to overall strength in the Yen crosses. With currencies expected to be on the discussion table at the latest G8 meeting, the finger pointing may now shift from China to Japan. The three step move by China will give foreign ministers little to criticize. Japan on the other hand has done nothing despite the significant weakness of their currency. The pressure is on now for the Japanese to take initiatives to strengthen their currency as well. The most logical way to do this would be through an interest rate hike. Unfortunately this puts the central bank in a very tough situation since economic growth has been weak. Last night, we had disappointments in both the tertiary industry index and in leading economic indicators. Despite the weakness of the Yen, aside from selected corporate profitability, the rest of the country has not really benefited. The key data releases next week are trade and inflation.

Canadian Dollar Hits 29 Year High on Strong Retail Sales
The Canadian dollar hit a new 29 year high today and came within 30 pips of its 30 year high. As we suggested yesterday, the wholesale sales number was a perfect indicator of today’s surprisingly strong retail sales figure. Spending in the month of March doubled expectations, rising by 1.9 percent, the second biggest gain in 3 years. Demand for autos was particularly strong, but sales of non-auto retailers also hit the highest level on record in the first quarter. The combination of strong inflation and retail sales raises the chance of an interest rate hike by the Bank of Canada later this year. However things should calm down in the week ahead with only leading indicators due for release. There was no Australian or New Zealand data released overnight although Finance Minister Cullen downplayed the chance for future rate hikes. In the week ahead, the only important releases are New Zealand trade balance and Australian leading indicators.


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