The US dollar and Japanese yen dominated on Friday as disappointing US economic data triggered declines in FX carry trades and equities amidst broad-based “flight to safety.” The most market-moving report was the preliminary reading of the University of Michigan’s consumer confidence survey, which surprisingly fell to a 5-month low of 63.2 in August from 66.0. A breakdown of the survey shows that sentiment on current conditions soured much faster than the economic outlook, suggesting that optimism reflected in last Friday’s US non-farm payrolls report was misleading. Furthermore, the survey showed that inflation expectations for 1-year and 5-years ahead eased back to 2.8 percent and 2.9 percent, respectively, and the latest US consumer price index (CPI) results indicate that expectations could fall even further. Headline CPI went unchanged during the month of July while the annual rate plunged 2.1 percent, the most since 1950, as most subcomponents fell, led by food, energy, and housing.
The one bright spot in all of the day’s US news was industrial production, which rose 0.5 percent in July due primarily to a surge in motor vehicle output. This is similar to what we saw in ISM manufacturing for the same period and adds to evidence that some of the only improvements in the economy, such as car production and housing sales, are the result of the US fiscal stimulus plan, including the “cash for clunkers” program and the $8000 tax credit for some new homebuyers. That said, the impact of these programs will not last forever, and a lasting US economic recovery may not be possible until demand for other consumer goods improves, which will be difficult in the face of rising unemployment and the shift away from spending via credit to increased saving.
Looking ahead to next week, Japan’s Cabinet Office will release preliminary growth readings on August 16, and after four straight quarters of contraction and a record drop in GDP during Q1, the results could offer a boost to risk appetite. Indeed, improvement in foreign demand during Q2 has helped lift export demand, and may ultimately be the driving force behind an expected 3.9 percent annualized increase in GDP, following a record drop of 14.2 percent in Q1. Consumer spending, however, may prove to be a drag on growth as wages have fallen amidst mounting job losses. All told, FX traders may see a brief fundamental response from the Japanese yen following the release of Q2 GDP, where positive news pushes the currency higher and negative results lead the currency lower. As European traders start to come in to play, however, risk trends may resume their place as the primary driver of price action.
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