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Pound sharply fell nearly 300 pips in the immediate aftermath of the S&P downgrading the outlook for the U.K. to negative from stable. The news overshadowed a better than expected retail sales print which kept the theme of improving fundamentals going for the economy.

Talking Points
• Japanese Yen: Services Sector declined Most In 12 Years
• Pound: S&P Lowers Outlook To Negative From Stable
• Euro: PMI Composite Rises To Eight Year High
• US Dollar: Philly Fed and Initial Jobless Claims on Tap

Pound Regains Footing After Being Crushed By S&P Downgrading U.K. Outlook to Negative From Stable

Pound sharply fell nearly 300 pips in the immediate aftermath of the S&P downgrading the outlook for the U.K. to negative from stable. The news overshadowed a better than expected retail sales print which kept the theme of improving fundamentals going for the economy. Consumer consumption rose 0.9% on a 3.5% gain in non-specialized stores. Also, an 11.9% increase in apparel sales from a year ago pushed the annualized figures up by 2.6%. However, the bleaker outlook by the rating agency is disputing the positive data and has traders worried that any recovery may not be that strong and may take the form of a u-shape rather than the preferred v-shape. Supporting a bearish bias was total business investment falling by 5.5% in the first quarter.

Standard & Poor's credit analyst David Beers said in a statement that We have revised the outlook on the UK to negative due to our view that, even assuming additional fiscal tightening, the net general government debt burden could approach 100 percent of GDP and remain near that level in the medium term. Markets are already concerned about the tax burden on consumer s going forward and if the government looks to extract more from Britons to offset their shortfall then the outlook for domestic growth will become dimmer and push out expectations for a recovery for the economy. We have seen sterling rise back above the 200-Day SMA at 1.5576 another break below the technical level would leave the 5/18 low of 1.5115 as the next form of strong support.

The Euro saw choppy price action as an improvement in the PMI reading help lift the single currency, but the pound's freefall would reverse those gains. The euro zone's services and manufacturing sectors contracted less than expected in May lifting the composite index to a eight month high of 43.9. The pace of the decline in new orders slowed which could be a sign that the economy is stabilizing and with the added efforts of the ECB improving the outlook for a recovery. After reaching as high as 1.3837 the EUR/USD dropped to 1.3740 and remains choppy as traders weigh the improvement in the outlook for the EZ economy against the impact of the dour outlook for the U.K. on their economy. Indeed, many had felt that the Euro-zone was lagging their neighbor in their recovery and the downgrade of the U.K. raises questions for their economy.

The U.K. downgrade added to the dour outlook by the Fed which could raise concerns over a global recovery and lend dollar support as traders look for safety. The FOMC minutes yesterday took the steam out of the improving outlook for the U.S. economy as they lowered their forecasts for growth in 2009 from a possible low of -2.0% to -2.5% and raised the upper bound of unemployment expectations to 9.2% from 8.5%. Therefore, we may see markets take their cue from today's fundamental data to see if it supports the central bank's new estimates. The Philadelphia Fed manufacturing indicator is expected to improve to -18.0 from -24.4 which would be the highest in eight months. The increase in activity will help ease some fears but as long it remains in negative territory optimism will be limited. The leading indicator gauge is also expected to improve to 0.8% from -0.3% and record the first positive reading in almost two years. However, initial jobless claims are expected to remain above 600,000 signaling that the labor market will remain a drag on any potential recovery. .

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To discuss this report contact John Rivera Currency Analyst: jrivera@fxcm.com