Strong US Retail Sales boosts USD a bit, keeps risk appetite alive for another round. AUDUSD looking wobbly

MARKET RECAP May. 14 2008:

move higher in yields in US and Europe deals another blow to JPY and CHF. GBP weak despite more high inflation data

THEMES TO WATCH – UPCOMING SESSION

Key Risk Events (All times in GMT)

France Apr. CPI (0640)

UK Apr. Jobless Claims Change and Avg. Earnings (0830)

EuroZone Mar. Industrial Production (0900)

UK BOE Inflation Report (0930)

US Apr. CPI (1230)

US Fed's Kroszner to speak (1315)

US Weekly Crude Oil and Product Inventories (1430)

US Fed's Lockhart to speak (1600)

New Zealand Mar. Retail Sales (2245)

Japan Mar. Machine Orders (2350)

New Zealand Apr. Business PMI (0000)

Market Comments

GBP had another day of heavy action. As with the previous day's PPI data, the CPI/RPI data were out at far higher levels than expected, even if the core CPI reading was still fairly muted. The data triggered a huge sell-off in the short sterling STIRs - enough, in fact to eliminate almost 50 bps of projected easing from the BOE for the remainder of the year. But still GBP managed to fall on the day, as apparently the worries over the implications of the housing market for the UK economy overshadow interest rate developments.

As a sideshow, the UK housing minister had the papers she was carrying caught on photo, papers that included projections of the UK housing market falling some 5-10 per cent this year. This is a bit of a silly development, but the RICS survey and the fact that UK New Mortgages have fallen to 33-year low is serious business and it appears clear that there are some heavy price drops in UK housing built into the pipeline in coming months. A good deal of UK inflation is likely due to the sharply weaker GBP vs. the EUR (a bigger than -15% drop over the last 18 months), a move that has been large enough to potentially keep inflation uncomfortably high for some time and prevent the BOE from administering the monetary medicine the UK so desperately needs. Adding the GBP woes is an extremely unpopular government that seems to be finding a barrage of criticism from all corners. Despite the endless laundry list of GBP's woes, however, we think most of the negativity is fully priced into the non-USD GBP crosses. Keep an eye on the Quarterly Inflation report set for release today for another key sentiment test on GBP.

Even without the influential gasoline component, the April US Retail Sales number was very strong and the previous month's data was revised strongly upward. We have a hard time imagining this is more than a one-off blip in an otherwise negative trend, however. After all, consumer confidence continues to probe new lows (note last night's weekly ABC confidence number), gasoline and other energy prices continue to steal buying power from other areas, and housing prices continue to fall. This is not the stuff for a shopping spree. We also suspect that egregiously dishonest US inflation data is behind much if not all of the perceived increase. Regardless, the stronger than expected US data had yields pulling strongly higher in US, such that further USD strength may be the order of the day if we're to take a lead from our yield comparisons. This is especially true in AUDUSD, where rates have hardly budged for some time while the US short rates especially have rallied. But the EUR vs. US comparisons are also poking to new recent lows, so the pressure appears to the downside for now in EURUSD. The one spoiler out there for the USD yesterday was oil, which spiked to a new record high in the wake of the US data, more than 3 dollars higher from the previous day's lows. The current US oil import bill runs at above $600 billion/year with oil at $125. Many are talking up the idea of a commodities bubble. We wouldn't dare to try calling a top.

The strong move higher in yields pulled the USD higher vs. JPY and CHF, which were relatively weak across the board yesterday. The JPY and CHF weakness feels like its in the 16th round of a 15-round match, but is likely to remain as long as the oddly hyper-optimistic equity markets can keep sentiment elevated and as long as the credit market continue to appear calm..