Weekly Treasury Update

Dollar
US economic data has been generally on the firm side with particular strength in the jobless claims data with a decline to the lowest level since late 2007. Despite uncertainty, there will be further speculation that the Federal Reserve will start to taper bond purchases at the September meeting. Yield considerations will be dollar supportive, but the currency will be very vulnerable if the Fed decides against a reduction in quantitative easing. Structural factors should provide support with an improving trade situation and dollar buying against the Euro by global reserve managers.
The dollar rallied at times, but struggling to sustain the gains with erratic reading in volatile conditions as liquidity declined. From peak in the 1.32 area, the dollar then spiked lower to the 1.3350 region.
The headline US retail sales data was in line with expectations with a 0.2% monthly gain for July. A modest upward revision to June’s figure and a stronger than expected core increase of 0.5% did put a positive gloss on the figures with the strongest underlying gain for seven months.
In response there was a significant rise in US Treasury bond yields which helped push the dollar higher. Regional Fed president Dennis Lockhart stated that a tapering of bond purchases was still possible in September, although further economic improvement would be needed. He also suggested that there would be a range of potential tapering amounts depending on forthcoming economic evidence.
The latest US labour-market data was again stronger than expected with a decline in initial jobless claims to 320,000 in the latest reporting week from a revised 335,000 previously and this put claims at the lowest level since late 2007 and there was also a solid reading for the New York Empire index. There was an increase in US yields as 10-year bond yields spiked higher following the data and the 30-year yield moved to the highest level since the fourth quarter of 2011 at just above 3.80%.
As far as inflation is concerned, headline and core consumer prices both rose 0.2% for July which was in line with expectations. Regional Fed president James Bullard stated that there had been an improvement in the labour market. He was still concerned that growth rates were disappointing while low inflation could also still be a problem. In this context, he was undecided whether to back a tapering of quantitative easing at the September FOMC (Federal Open Market Committee) meeting.
The Philly Fed index was slightly weaker than expected which dampened optimism to some extent and the industrial output data was weaker. The latest capital data recorded a sharp outflow of long-term capital for June with heavy net outflows and a sharp drop in Chinese bond holdings. This will tend to increase fears over a potential rise in US bond yields and would also tend to have a mixed impact on the dollar given financing concerns.

Euro
There will be further relief surrounding the short-term eurozone outlook with a return to overall growth for the second quarter. There will still be major concerns surrounding the peripheral outlook and the perception that the crisis has eased will make it even more difficult to enact structural reform. Political tensions will also intensify ahead of September’s Federal election. There will also be pressure on the European Central Bank to resist any monetary tightening through a stronger euro and overall confidence could deteriorate rapidly again. The single currency held a solid tone overall with hopes for a sustained recovery in the growth outlook.
The headline German ZEW data was stronger than expected with an increase to 42.0 for July from 36.3 the previous month, maintaining the general run of stronger than expected German releases this month. ZEW economists speculated that the ECB could increase interest rates, which briefly pushed the euro higher, although the market gave little credence to the reports. The stronger than expected second-quarter GDP releases from Germany and France helped produce a 0.3% gain for the eurozone as a whole, the first increase for seven quarters.
There was a significant increase in German bond yields at the latest auction with 10-year rates at the highest level for over 12 months at 1.8%. Growth helped maintain a more confidence mood surrounding the eurozone outlook despite important reservations surrounding the peripheral economies. There were also concerns that the Dutch economy contracted again which suggests trade volumes are still weak. The euro attempted to move higher following the data, but failed to make any significant headway and dipped lower to test Tuesday’s support levels.
Range for previous week: $1.3188–$1.3400
Range for this week: $1.3050–$1.3420

Sterling
There will be greater economic confidence in UK growth prospects following a stream of stronger than expected data. The Bank of England will remain an important focus, especially as the MPC (Monetary Policy Committee) will look to protest against the rise in UK bond yields to the highest level since 2011. If the data remains strong, however, markets will price-in an earlier increase in interest rates which will support Sterling. There will be a sustained increase in volatility as uncertainty continues and the UK currency will be vulnerable to heavy selling pressure if there is evidence of a renewed deterioration in UK conditions. Sterling maintained a robust tone during the week with 8-week highs above 1.56 against the dollar and near 0.85 against the euro.
The UK consumer inflation data was in line with expectations with a small decline to 2.8% from 2.9% in the latest month. There was some relief that a stronger figure was avoided which would ease pressure on the BoE to raise rates.
The other data maintained its recent trend of beating market expectations as the claimant count fell sharply by 29,200 for July from a revised 29,400 decline the previous month, the biggest monthly declines since 2010. Unemployment held steady at 7.8% for June while there was a stronger reading for average earnings.
As far as the BoE minutes are concerned, there were 9-0 votes to leave interest rates and quantitative easing on hold at the August meeting. The MPC also voted on the forward guidance introduced alongside the latest inflation report. In this case there was an 8-1 vote for its adoption with Martin Weale voting against as he wanted a more robust inflation clause to trigger a potential over-ride low interest rates.
Retail sales rose 1.1% in July from 0.2% the previous month. Hot weather conditions are likely to have triggered additional spending during the month and there were still concerns whether the trend would be sustainable, but there was renewed buying support for Sterling on recent economic trends.
There was a further increase in market rates with the benchmark UK 10-year gilt yield rising to the highest level for two years. There were further expectations that the BoE would be forced to raise interest rates earlier than expected in the recent inflation report which continued to underpin the UK currency.
Range for previous week: $1.4812–$1.5751
Range for this week: $1.5504–$1.5702

Yen
The Bank of Japan will maintain a very loose policy and yield considerations will remain a negative yen influence. Tax considerations will remain important given the implications for the Nikkei index which will also have an important impact on the Japanese currency with the sales tax likely to be yen negative. There will be pressure to remain a competitive yen, especially given underlying stresses in Asian economies. The yen will gain some support when risk appetite deteriorates, but will find it difficult to sustain any significant gains.
The dollar was unable to push above 98.50 area against the yen during the week. There was an increase in exporter dollar selling at higher levels, although pressure was still countered by solid US support on yield grounds.
The latest Japanese capital data recorded further outflows from Japan in the latest week and there was an increase in outflows compared with the latest week which should tend to undermine the Japanese currency.
There were media reports from officials denying that the government would consider cutting corporate taxes. These comments triggered sharp losses for the Nikkei index and the correlation between Japanese stocks and the currency pushed downward pressure on the dollar against the yen with lows near 97 in choppy trading conditions.
The yen gained some support from a significant retreat in US and global equity markets during the day. With liquidity at low levels, there was important evidence of stop-loss activity.
Range for previous week: ¥97–¥100
Range for this week: ¥97.12–¥98.340