US Dollar Finally Falls From Nearly 8-Month Highs

US Dollar Finally Falls From Nearly 8-Month Highs
The US dollar tumbled across the majors, especially against high-yielders, as the currency remains vastly overbought. Indeed, we’ve been saying for days that the extensive dollar rally was due for a retracement, and the move finally came despite the release of mixed economic data. First, the US producer price index jumped 1.2 percent in July, pushing the annual rate to a 26-year high of 9.8 percent. As usual, the bulk of this increase was due to energy and commodity costs, as the core measure rose 0.7 percent during the month to bring the annual rate up to 3.5 percent. However, the dollar’s reaction was relatively muted, as the markets are already well aware that inflation is a problem in the US, given the jump in US CPI last week to a 17-year high of 5.6 percent. Furthermore, recent commentary by Federal Reserve officials suggests that the central bank will opt to leave rates steady this year in an effort to allow an economic slowdown to cool price pressures.

Meanwhile, US housing starts fell more than expected to a 17-year low of 965K in July while applications for building permits slumped to 937K from 1138K. As we saw in Monday’s release of the NAHB index, homebuilder sentiment has been particularly pessimistic as they are faced with the reality of excess home inventories and weakening demand. Overall, it is clear that the housing recession is far from over, and with home values likely to continue falling the outlook for financial institutions remains bleak.

Euro Bounces as Investor Outlooks Improve
The Euro managed to recover from 6 month lows on Tuesday as the German ZEW survey of investor sentiment rose more than expected to -55.5 in August from a record low of -63.9.

It appears that falling oil prices and a weakening euro helped to boost confidence in the outlook, which is similar to what we saw in the latest US consumer confidence reports. However, investors remain concerned about current conditions, as this component was worse than expected at -9.2, down from 17. Nevertheless, the move in EUR/USD likely had more to do with the fact that the pair was simply very oversold, and with forex positioning showing that traders are turning increasingly bearish on the pair, the contrarian indicator suggests that the pair should rise further.

British Pound Awaits BOE Meeting Minutes
The British pound has done little but consolidate above nearly 2-year lows, but if the release of the Bank of England’s meeting minutes from August are anywhere near as market-moving as the BOE Quarterly Inflation Report, GBP/USD may not hold near current levels for long.

During the July meeting, the minutes revealed that there was a 7-1-1 vote to leave rates at 5.00 percent, with one dissent in favor of a 25bp hike and one in favor of a 25bp cut. With indicators of growth continuing to deteriorate and inflation figures reflecting rising prices, there is potential for there to be yet another split vote this time around, and such a result is unlikely to have a big impact on GBP/USD. However, given the revised GDP and CPI projections in the Quarterly Inflation Report, I think there’s some potential for additional Monetary Policy Committee members to have voted for a rate cut. Indeed, a 6-2-1 or 7-2 vote count could weigh heavily on the British pound on Wednesday morning, but if there is sufficiently hawkish rhetoric contained within the minutes, the UK currency should hold above the recent lows.

Commodity Dollars Gain On Oil, Gold - Canadian Dollar Faces Retail Sales
The Australian dollar, New Zealand dollar, and Canadian dollar all gained on Tuesday thanks to a bounce in crude oil and gold futures, along with a broad decline in the US dollar.

The only release of note was the minutes from the Reserve Bank of Australia’s August meeting, which supported market expectations for 100bps worth of rate cuts within the next 12 months, according to Credit Suisse overnight index swaps, as they said that slowing demand gave them increasing scope “to move towards a less restrictive setting of monetary policy.” However, don’t expect a change in rates anytime soon, since the RBA still judges that inflation risks remain high. Indeed, until consumer price indicators start to fall closet to target in late 2008 or 2009, the central bank is likely to leave rates steady at 7.25 percent. Looking ahead to Wednesday, Canadian retail sales will be released. As I mentioned in my outlook for the 5 key events this week, wholesale sales tend to be a good leading indicator for the retail figure. Given the stronger-than-expected 2.0 percent reading we saw this morning, retail sales could be a better than forecasts as well, which should help the Canadian dollar rise on Wednesday.