USD Faces Retail Sales Hurdle

The U.S. nonfarm payrolls (NFP) report for May did not disappoint. On the contrary: it surpassed expectations with 280,000 new jobs added and increased the likelihood of a Federal Reserve rate hike before year’s end.

However, the USD was not able to sustain the positive boost given by the employment report. The buck’s rally was short-lived as there was no additional data to support the probability of a benchmark interest rate hike. In order for the market to get behind the USD, economic indicators have to show that the U.S. economy could sustain a rate increase.

Fickle American Consumers A Concern

The U.S. retail sales indicator has stopped dollar rallies in the past, and this time the currency does not have a lot of momentum, so the impact could be even more damaging to the dollar’s strength.

If American consumers are not spending their energy- and food-related savings, the retail sales forecast of 1.1% could be closer to the neutral 0.0% reading last month. In which case, expect the market to punish a failure to outperform expectations with a dollar selloff, and for questions about the Fed’s plans to raise rates get louder. The impressive NFP report for May has restored confidence in the central’s bank pending decision, but further evidence of the same factors that stunted growth in the first quarter will once again raise doubts ahead of the Federal Open Market Committee meeting on June 17.

Core retail sales, excluding auto, are expected to be at 0.7% after the disappointing 0.1% reading in May. Consensus among analysts is for the U.S. retail sales figures to improve over last month’s disappointing report. Much of that optimism is being driven by the rise of improving vehicle sales.

Consumer confidence must also support the theory of a strengthening economy by way of improved sentiment but reality tells a different tale. Americans are largely opting to save their money or use it to pay down debt, in turn hurting retail sales, and further impairing economic growth.

A Cautious Approach Is Needed
Employment has been the strongest pillar on which the Fed has built its case for an economy that can sustain higher interest rates. The NFP validated that thinking although several questions were raised about how transitory the factors were that plagued the first quarter of 2015, and how likely they were to affect the second quarter. What a difference a strong release makes. Now, a rate hike seems plausible once more.

June has already been ruled out by Fed Chair Janet Yellen, but September or October could prove to be the moment of truth. September may be more likely given there is a press conference scheduled following the monetary policy statement. The Fed could use the opportunity to address any concerns from investors.

Regardless, a rate hike this year seems inevitable despite the International Monetary Fund’s Managing Director Christine Lagarde’s recommendation to the U.S. central bank to delay tightening its monetary policy until 2016. What is not certain at this point is if the Fed will make a modest interest rate hike this year before implementing a more meaningful rise in 2016. Taking the gradual approach would give Americans time to adjust, as well as send a signal worldwide that the U.S. economic recovery is indeed real.

The U.S. retail sales, core retail sales, and unemployment claims will be released at 8:30 a.m. ET on June 11.

Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza