Dollar Rallies on Strong Retail Report. All Eyes on Fed

The U.S. dollar put in a somewhat mixed performance ahead of key retail sales data and the Federal Reserve’s FOMC monetary policy announcement this afternoon. The greenback pushed higher against the euro and Japanese yen but was largely flat against the British pound and Aussie dollar. Recent strength in U.S. economic figures have bolstered optimism that America’s recovery is gaining more traction and that perhaps, the Fed may begin to normalize monetary policy sooner than its current 2014 target.  While no change in lending rates or the Fed’s asset purchase program is expected this afternoon, officials’ statement will be dissected for any clues that suggest a slightly more neutral policy stance going forward. The dollar would benefit from officials’ acknowledgment of the recent positive economic reports and from the lack of talk about additional policy support for the U.S. economy.  

The euro continued to struggle just above a one-month low against the U.S. dollar, despite Greece having reached a debt swap agreement with its bondholders last week. Investors continue to focus on the very weak peripheral economies in the euro zone, which will continue to challenge efforts to bring fiscal deficits down to more manageable levels. Mounting political uncertainty in France and Greece could also raise doubts about the implementation of agreed-upon fiscal reforms that were conditions of previous bailouts. A less dovish than expected Fed statement this afternoon or a solid retail sales report this morning could push the dollar higher against the single currency.

Despite the fact that the Bank of Japan did not follow up last month’s surprise monetary policy easing with another similar move overnight, the yen fell to a new 11-month low against the greenback. Expectations that additional easing is still likely and the improving economic backdrop in the U.S. should keep dollar/yen biased higher.

EUR: The euro struggled just above key technical support at its 55-day moving average against the dollar. Last week’s agreement between Athens and its bond holders, helped avoid a messy default, but failed to meaningfully change the market’s opinion about the 17-member bloc’s debt crisis. While a positive, the debt swap does nothing to address the fact that Greece’s economy is contracting at its fastest rate in decades, that Italy’s economy is in recession and that outside of Germany and France, most of Europe’s economies are at best, stagnant. There is also growing political uncertainty in Greece, which will have a general election in April. The risk is that a newly elected government could quickly abandon the deeply unpopular austerity measures imposed on Greece as a condition for receiving the latest 130 billion euro bailout. An upcoming election in France also risks seeing unpopular bailouts become a dominant campaign issue, which could call into question the nation’s appetite for continuing to support other struggling euro zone states. On balance, the euro should struggle to sustain any strength over the coming weeks.  

JPY: The Bank of Japan, who met overnight, did not follow up last month’s surprise increase in its asset purchase program with any additional monetary easing, as some had expected. The BOJ’s surprise move last month was partly responsible for the broad decline in the yen, which she nearly eight percent of its value in February alone. Despite that, the yen fell to an 11-month low overnight. Investors still expect the BOJ to remain very accommodative for the foreseeable future, an outlook that should keep the yen pressured. Moreover, the nascent improvement in U.S. economic data has improved the outlook for U.S. yields and has in-turn, added to the upward pressure on dollar/yen. A less dovish than expected Fed statement today should keep the pair trending higher still.     

GBP: The pound held its ground against a generally firmer U.S. dollar, partially supported by a better than expected reading of the U.K.’s balance of trade. The U.K. posted a deficit of £7.53 billion in January, slightly better than the forecast for £7.88 billion. Still, the pound remains vulnerable to a sustained downturn in the euro and in investor risk appetite in general.

CAD: The Canadian dollar firmed against the greenback, despite a recent bout of below-consensus domestic data. Firmer stocks overnight and improving U.S. economic data helped support the loonie, which could remains buoyed if the idea of a U.S. recovery gains further traction.

USD: Retail sales rose by 1.1%(m/m) in February, above expectations for a 1.0%(m/m) rise. Ex-autos, sales were up 0.7%(m/m) and ex-gasoline, retail sales were up 0.8%(m/m). Combined with solid upward revisions to January’s figures, the retail sales numbers pushed the USD to fresh highs. 

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