The US dollar has strengthened across the board following a much better than expected retail sales report. Consumer spending increased 1.0 percent in May, the strongest pace of growth in 6 months thanks to tax rebates and higher gasoline prices. Aside from the miscellaneous category, retail sales increased across the board. As the Bush Administration has hoped, Americans are spending rather than saving their tax rebates. This number indicates that the economy most likely skirted negative GDP growth in the second quarter which fueled speculation that the Federal Reserve could raise interest rates before the end of the year. According to the latest Fed fund futures, the market has already priced in a 96 percent chance of at least a quarter point rate hike in September. There is a 67 percent chance that the rate hike could happen in August. These are difficult times for the Federal Reserve who knows that even though recent economic data reinforces their plans to keep interest rates steady, economic growth could easily falter in the coming months. However at the same time, inflation and inflation expectations continue to rise. Although crude oil prices have retraced, they are still hovering near record highs while floods in the Midwest have driven corn prices to all time highs. There is little respite for food and gasoline prices which is why the market believes that despite the risks to growth, the Federal Reserve will have to raise interest rates and not just once. Consumer prices are due for release tomorrow and this will confirm or deny the need for a rate hike. When growth is weak, making inflation a top focus could lead to even weaker economic conditions in the future. Jobless claims jumped to the highest level since March while continuing claims reached their highest in 4 years. More people are losing jobs, raising the risk of a further slowdown in the US economy, but for the time being, the prospect of slower growth is a secondary priority for the Federal Reserve.

EUR

Stronger Eurozone economic data and hawkish comments from the European Central Bank have failed to prevent the Euro from succumbing to the better than expected US retail sales report. The ECB’s commitment towards fighting inflation is well known, which is why FX traders were not surprised by the release of the ECB monthly bulletin, which confirmed that the central bank is in a state of ‘heightened alertness.’ The warning that they stand ready to act to counter inflation has already been priced into the markets. The possibility of a rate hike by the Federal Reserve on the other hand, is completely new. Eurozone industrial production and French non-farm payrolls were both stronger than expected, reinforcing the ECB’s hawkish bias. Unlike the US, the downturn in the Eurozone economy has been limited, which puts them in much better shape to raise interest rates. Although ECB member Stark suggested that a rate hike would be one-off, if the Federal Reserve can raise interest rates more than once, so can the European Central Bank.

GBP

The British pound is closing in on its 3 month low despite the fact that inflation expectations hit the highest level in 15 years. Central Bank governor, Mervyn King attributed the rise in inflation to rising commodity prices. BoE officials are keeping a close watch on the wage rate, for indications of future inflationary pressure. Speculations rise that the BoE would soon be hiking their key interest rate in order to sustain the economy from inflation, however it remain to be seen if Mervyn King would be quick to react, as the economy experiences slowing growth. Due to lack of economic data, investors look forward to next week when consumer prices and retail sales are due for release. In addition, markets will be paying a lot of attention to BoE minutes, in order to attain a clear understanding of central banks sentiment. For the time being, the pound is weak against the dollar and the US CPI report will dictate how the GBP/USD trades over the next 24 hours.

AUD/CAD/NZD

The Australian dollar plummeted following the surprise drop in employment last month. The market was expecting a rise of 13,500 jobs, but instead, 19,700 jobs were lost between April and May. The unemployment rate increased from 4.2 to 4.3 percent, putting an end to 19 months of consecutive job growth. Prior to the employment report, there was widespread belief that the Reserve Bank of Australia would raise interest rates in the coming months and even though this report certainly throws a wrench into those forecasts, the acting Treasurer reminded the market that there is no room for complacency in their ‘war’ against inflation. New Zealand retail sales are due for release this evening. Although they are expected to be rebound due to an improvement in credit card spending, business PMI dipped into contractionary territory last month, so traders should not completely rule out a miss. The Canadian dollar on the other hand has only weakened slightly against the greenback.

JPY

The US dollar is closing in on its 4 month high against the Japanese Yen as stronger US economic data drives the currency pair higher. Industrial production and consumer confidence are due for release this evening along with the Bank of Japan interest rate decision. Despite rising inflationary pressures, the Bank of Japan is not expected to raise interest rates until the end of the year, at the earliest. Japan also officially raised meat prices, which is a confirmation that inflation is hitting the country hard.

GBP

The British pound strengthened against the US dollar today despite weaker economic data. UK unemployment rose to the highest in seven months as jobless claims increased 9,000 to 819,300. This followed a revised jump of 11,200 claims in April, as companies continue to cut workers as growth stalls. Financial service companies lead the job losses, as the effects of the subprime mortgage crisis linger. The deteriorating labor market has also begun to depress wages as April’s growth in average earnings including bonus slowed to 3.8 percent from 4.0 percent in March. Meanwhile, the trade deficit grew to -£7594 from a revised -£7147 as a 3.7% increase in exports was outpaced by rising imports. The current housing slump and rising inflation has squeezed consumers and weighed on domestic consumption, which will suffer further as job losses mount. The BoE has turned hawkish in the face of inflation rising to its 3% threshold, but the weakening economy confirms that their decision to leave interest rates unchanged next month will not be an easy one.

AUD/CAD/NZD

The Canadian, Australian and New Zealand dollars all strengthened against the greenback as oil and gold prices edged higher. New concerns about supply drove crude oil prices up more than $5 a gallon while gold, which is often seen as an inflation hedge increased more than $14. Australian employment numbers are due for release this evening and even though consumer confidence fell to a 16 year low, employment growth may have actually increased last month because the employment components of both the service and manufacturing PMI reports accelerated. New Zealand on the other hand will be releasing their business PMI report and food prices. We expect the Australian dollar to continue to outperform the New Zealand dollar.

JPY

The com bloc lost the support of its commodity correlation Friday as volatility for crude and gold settled. Instead, trading in the Canadian, Australian and New Zealand dollars were guided by active fundamental speculation. The loonie was arguably the most active currency among the three as traders received the growth numbers for March and the first quarter. Both readings would weigh on the Canadian dollar. Through March, the world’s 14th largest economy cooled 0.2 percent. Far more concerning though, the quarterly figure posted its first negative reading since 2003. Canada’s 0.3 percent clip of negative growth draws a notable contrast to the US’s as of yet positive readings. What’s more, the breakdown shows that the pressure on the economy is not just from the manufacturing sector’s troubles with unfavorable exchange rates and high input costs, but from trade and housing as well. For Australia, the Private Sector Credit report for April was a surprise fundamental driver. The 0.4 percent climb marked the smallest increase in borrowing in seven years - a reflection of high credit costs and perhaps fading consumer spending. No doubt, this will be a reading to consider next week when the RBA meets. There last report suggested they were considering a rate cut ealier this month. The RBNZ will likely raise similar concerns at their decision on Sunday.

Majority of all currencies are traded against the US Dollar. The four most traded currencies against the US Dollar are the Euro (EUR), Japanese Yen (JPY), Pound Sterling (GBP) and Swiss Franc(CHF). As currencies are traded in pairs and exchanged one for the other when traded, the rate at which they are exchanged is called the exchange rate. These four currencies traded against the US Dollar make up the majority of the market and are called major currencies or the majors.