The USD gained against most major currencies on Tuesday based on the stronger than expected retail sales report and inflationary talk.
The surprise strength in the retail report forced financial market traders to increase their bets that the Fed is likely to leave rates unchanged at their next meeting on June 25. Cleveland Fed President Sandra Pianalto reiterated the Fed's concern over rising inflation. Both factors sent signals through the market that the economy is stabilizing and further rate cuts may not be necessary.
In a breakfast speech Fed chairman Bernanke stated that the financial markets remain unsettled. Although he did not say much about the Fed's current stance on further interest rate cuts, he did say that the Fed would increase its auctions of cash to banks as needed. This sounds like a potential inflationary move which would be supportive to the Dollar.
ECB Council member Christian Noyer reiterated the European Central Bank's firm stance against inflation. He also added his concern that some Asian and Middle Eastern governments pose an unstable and dangerous inflation threat to the world economy by linking currencies to the Dollar.
It is clear at this time that both the Fed and ECB are concerned about inflation. The Fed seems to be having a hard time finding a strong inflationary trend in energy and food prices, but the ECB seems to be finding it everywhere. This is where the battle line has been drawn. The question is will Wednesday's U.S. CPI report show a developing trend in higher inflation or will it show inflation stabilizing?
Fundamental traders should continue to monitor reports out of the Euro Zone regarding consumer/business confidence and economic reports. Any series of weak economic reports may shift the ECB's tone regarding interest rates from hawkish to dovish.
The conclusion is to play both sides of the market until there is a sign that the bulls are ready to add to their commitment to the long-side of the Dollar. The EURUSD may stay locked in a range between 1.60 and 1.52 until either one of the central banks makes the next move regarding interest rates.
One noticeable shift in trading style has been evident lately. Traders seem to be reluctant to pay up for the Euro when it comes close to breaking out to the upside. With a possible long-term down trend set in motion, look for the next selling opportunity in the EURUSD after a retracement back to at least 1.5620.
Bank of England Has to Decide Where to Fight the Battle
Housing and property values are providing a bearish tone to the GBPUSD while inflationary fears have put the Bank of England in a difficult position.
The issue at this time is whether or not the Bank of England should continue to cut interest rates. Reducing rates would provide a stimulus to the economy, but would weaken the currency. Raising rates to fight inflation could squash growth possibilities.
Based on the trading action Tuesday, it looks as if traders are betting on another interest rate cut. Continue to look for support to erode and for this pair to trade under 1.9200.
Are the Japanese Yen and Swiss Franc Ready to Decouple from the Stock Market?
Despite the selloff in the U.S. stock market on Tuesday, the Dollar remained firm against the Japanese Yen and the Swiss Franc. This is the second time in a week that this occurred which may be a signal that these pairs are getting ready to decouple from the stock market. Although more evidence is needed to see if the trend is beginning to turn, it does not seem like traders are automatically willing to sell Yen and buy Dollars on bullish days or buy Yen and sell Dollars on bearish days.
Small speculators should watch for trading traps and not automatically assume a carry trade is going to take place.
Strengthening Economy and Firm Energy Prices Support Rally in Canadian Dollar
The USDCAD traded lower on Tuesday as traders continue to focus on the surging crude oil market and the strengthening Canadian economy.
Back-to-back strong economic reports in employment and housing have provided support for the Canadian Dollar and have sent signals to the Canadian financial markets that another interest rate cut may not be necessary.
For several months the pair has been trading inside of a tight range. An improving economy coupled with higher crude oil could prove to be bearish for the USDCAD.
Slowing Economy Provides Support for Aussie and Kiwi
The AUDUSD and NZDUSD have been under pressure lately as government reports are indicating that the series of interest rate hikes earlier in the year have finally led to a slowdown in the economy.
Although technically oversold and vulnerable to sharp short-covering rallies, continue to look for downside pressure to dominate these markets as the U.S. Dollar picks up strength.
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