Intervention Drawing Near

G8 finance ministers met last week to discuss the detrimental effects of rising (commodity) prices on the global economy. Oil prices and commodity prices have in some cases doubled over the last year, contributing to a nasty surge in worldwide inflation rates. While the Dollar was not technically a topic of the discussion at these particular meetings, it was broached tangentially because of the perceived relationship between the weak Dollar and high commodity prices. Accordingly, Central Bank intervention on the Dollar's behalf could theoretically be justified on the basis of both mitigating inflation and facilitating global macroeconomic stability. The "I" word hasn't been mentioned explicitly, but its likelihood increases with every up-tick of inflation and every down-tick of GDP. It is no surprise that in the weeks leading up the actual G8 conference, the Dollar has sustained its strongest rally against the Euro in nearly 3 years. Forbes reports:

Last week Federal Reserve Chairman Ben Bernanke flagged a change in Washington by linking the weaker dollar to inflation and saying he was watching the currency closely with the Treasury. Then U.S. Treasury Secretary Henry Paulson refused last week to rule out direct intervention in currency markets.

Euro Rallied on Trichet Comments

The euro rallied broadly after ECB President Trichet delivered surprisingly hawkish comments following a widely expected unchanged rate decision.

Trichet indicated that some ECB officials argued for rate hike later this year, and the central bank is in a state of “heightened” alertness” over inflation. His comments added to expectations for a rate move on its July meeting. The euro rose sharply from around 1.54 to as high as1.5562 versus the dollar, and gained more than half a cent to a 9-day high at 0.7956 versus the sterling. Also the euro advanced against the yen to test a key resistance at 165.

As Trichet’s statements dominated the market, other data released today were largely ignored. The Bank of England also left its interest rates unchanged at 5.0%. US weekly jobless claims fell 15k to 357k and continuing jobless claims fell slightly to 3.093m. The dollar edged up initially after the data but the following Trichet’s talk erased its gains quickly.

Dollar Slid after Jump in Unemployment Rate

The dollar slid across the board after a report showed US unemployment jumped to the highest since 2004. US non-farm payrolls fell 49k in May, in line with the estimate of a 50k loss. However, unemployment rate shot up from 5.1% to 5.5%, the largest month increase since 1986. The report showed the nation’s job market is still very weak and there is no sign that the market will turn in short term. After the report, the euro rose immediately from 1.5580 to 1.57 and extended its gains later. The dollar dropped 1 cent to close to 105.

The euro remained firm on higher expectations for a July rate hike after ECB President Trichet’s ultra hawkish comments yesterday. However, one thing should be aware of is that recent data all pointed to a slowing economy in euro zone. A report released this morning showed Germany industrial output dropped unexpectedly.

Canada job report for May was also released today. Unemployment rate was unchanged at 6.1% and jobs change lowered from 19.2k to 8.4k.

USD Rallies on Jawboning, Housing Data

The dollar rallied sharply against the majors at the start of the week as traders focused on US economic reports released in the morning, breaking through the 106-level versus the yen. Propping the greenback higher today was an unexpectedly stronger report on pending home sales, prompting speculation that the struggling US housing market may be bottoming. Pending home sales for April surged to 6.3%, far exceeding estimates for an improvement to -0.5% from -1.0% a month earlier.

Key highlights from the US economic calendar include the April trade balance, June consumer sentiment, the Fed’s Beige Book, retail sales, business inventories, and May CPI. Markets will focus closely on the US trade deficit and gauge the impact of soaring energy prices in recent months. Consensus estimates anticipate the deficit to expand to $60.0 billion, up from $58.21 billion from March. Retail sales are seen reversing the 0.2% decline in April, rising by 0.4%. Meanwhile, core retail sales are expected to remain unchanged at 0.5%.

The greenback also found support from US Treasury Secretary Paulson and NY Fed President Geithner, who both left open the option for central bank intervention. Nonetheless, we interpret the risk for government intervention in the currency market to prop up the do

Retail Sales Prop the Dollar

The greenback extended its gains versus the majors, rallying above the 108-level against the yen and 1.5380 versus the euro. The main catalyst for today’s move was a larger than expected improvement in May retail sales, with the headline reading improving by 1.0%, exceeding calls for a 0.5% increase from a 0.2% decline in April. The excluding autos retail sales jumped to 1.2%, versus estimates for an improvement to 0.7% from 0.5%. Weekly jobless claims crept higher to 384k, versus 357k in the previous week while April business inventories improved to 0.5% from 0.1% a month earlier.

With market sentiment anticipating the FOMC to shift to a tightening bias near the end of the year, traders will continue to closely scrutinize incoming US economic data. Philadelphia Fed President Charles Plosser echoed a similar tone to recent Fed comments, saying the FOMC needs to take preventive measures to ensure that “inflation does not get out of control”. Plosser said the current risk to inflation is serious and the Fed needs to act preemptively to contain it.

Economic data due out on Friday will provide additional clues on how quickly the Fed may need to move to contain inflationary pressures. The May CPI reading is expected to edge up to 0.5% from 0.2% a month earlier, and hold steady at 3.9% from the previous year. Core CPI is forecasted to rise to 0.2% from 0.1% in April and remain unchanged at 2.3% from a year earlier. Traders will also focus on the June University of Michigan consumer sentiment survey, which is expected to slip further to 59.5, versus 59.8 in May – which would be a fresh 18-year low.