On Friday US retail figures showed consumers are tightening their belts and the recovery may not be a sure thing. The data showed a quite dramatic drop of -1.2% MoM in May, compared to the forecasted 0.3% gain. The main drop came in the recessionary sensitive areas of autos and construction materials as a result of a removal of government backed incentive schemes. There were some provisos such as the fact that retail sales have already shown a very strong first quarter in 2010 with a 3% increase from Jan to April and that consumer sentiment remains buoyant, but although a dip was bound to come sometime - one of this magnitude is a little more worrying – as new trends always tend to begin with information shocks. Internet sales still showed an increase but they tend to be on discounted items. This came after the disappointing non-farm payroll figures last week and the trend in improving fundamental data for the US seems to have stalled. Actually as the FT journalist James Mackintosh has pointed out weak fundamentals may, ironically have the opposite effect on the Dollar to what one would expect. Whilst normally they would devalue the Dollar this time they may benefit the Dollar as safe haven demand tends to fall away with improving fundamentals so the opposite may help strengthen the Dollar. Over the following weeks investors will probably be waiting to see if this is the beginning of a fresh cycle of poor data or merely a blip in the trend up. The Greenback finished the day marginally up against the Euro at $1.2111 and gained more substantially against the Pound to $1.4548.

   The Euro stalled in its rally on Friday after an unbroken series of consecutive up days. Overall it was a positive week, however, in which confidence grew in the Euro as investors began feeling better about the global recovery. Better than expected economic data from China, Japan and Europe all helped and bond sales of European sovereign debt during the week were surprisingly successful showing investors were still willing to lend to Europe, even to struggling peripheral nations like Spain, Portugal and Italy; although some economic commentators have pointed out that the debt was leant at rather high rates. Finance ministers also met last week to hammer out the details of the European stabilization fund and Estonia gained admittance into the Euro after showing model discipline in controlling the finances of its small state following the global economic slow-down. Apart from lingering effects of the ill-timed comments of Hungarian and French government officials there was no serious bad news or further rating downgrades of countries in Europe. Finally, Germany, Italy and Spain announced austerity measures and made a stab at tackling entrenched labour laws; and the German parliament successfully passed a bill agreeing to its contribution to the stabilization fund pot. Overall this may well be a turning point for the Euro, which ended Friday’s session slightly down against the Dollar at $1.2111 and was up substantially against the Swiss Franc at SFr1.3917.

   The Pound was holding up rather well but that changed somewhat at the end of last week. Over recent days it has come to light that growth estimates of 3% in the next year were over exaggerated. Prime Minister David Cameron last week said things were worse than he had thought and investors will find out how much worse on the 22nd of June when Chancellor George Osborne delivers his emergency budget. There was also the recent warning from ratings agency Fitch about the UK’s debt, and the threat of a downgrade is ever present. A drop in UK manufacturing production did not help as data had been quite positive over recent months. Interest rates remain some of the lowest in the world benefiting the economy and the important housing market, but with the US considering a possible rate hike the interest rate differential could make the Pound an increasingly less attractive option for investors looking for a decent yield. The UK’s balance of trade figures remain weak encouraging a weaker pound as a counterbalance to give a fillip to lagging exports. The myriad austerity measures and cuts implemented by the UK’s European neighbours with which it shares nearly 50% of trade might also have a negative impact on the economy as a tightening of spending across Europe impacts on UK exports - already made less competitive by the recent rally of the Pound/Euro. There are signs of increased political in-frightening and instability beneath the surface of a supposedly united coalition as Liberal Democrats want a hike in capital gains tax to fund a tax cut for the poor and the Conservative right want to keep it at its present levels. There seems to be a conflict of opinion between economists who believe cuts are needed as soon as possible those who think it could derail the fragile recovery. It seems the government is in a catch-22. Investors will be eying the emergency budget on the 22nd June for more evidence but meanwhile the outlook is not as rosy as before for Sterling. The Pound fell on Friday to $1.4548 against the Dollar and £0.8322 against the Euro.

   The Yen continues to strengthen despite concerns that this will impact negatively on exports. The new Prime Minister Naoto Kan said last week he was so concerned at Japan’s national debt comparisons with Greece would not be far fetched. However, if he was hoping for a ‘Hungarian style’ sell off as a result of these comments he was wrong as the Yen did not particularly react – at least not on the scale he may have been hoping for. The Yen is still the no1 international safe haven play for investors  and it may well gain if the Dollar’s fundamentals start to weaken as they have been over the last few weeks. Despite continued deflationary trends last week’s GDP was stronger than expected as 5% growth and the fundamental data continues to be broadly positive. Yen must also stand to gain from strong neighbours. Last week saw indications the emerging economies of the East may still provide the engine rooms of recovery as China revealed an incredible 48% gain in exports – although commentators are saying this is the beginning of the end as Beijing puts on the dampeners to prevent inflation. But broadly speaking prosperity for Japan’s neighbours will help Japan as many visit and spend money in Japan or are major trading partners. The outlook continues to be for a strong Yen, nevertheless it closed down slightly against the Dollar on Friday at ¥91.63 and down slightly against the Euro at ¥110.98.

Analysis prepared by:

Joaquin Monfort
Forex4you analyst