How could today’s US retail sales data impact the dollar?

Investors were in an optimistic mood on Thursday, with some strong macroeconomic and corporate earnings data calming concerns surrounding the prevalence of ‘stagflation’ in the global economy.

Risk currencies have bounced back across the board in the past couple of days at the expense of the safe-havens. Indeed, every other G10 currency rallied against the US dollar yesterday, save the Japanese yen, with the greenback set for its firstly weekly decline since the start of September. The key EUR/USD pair has risen back above the 1.16 level, having spent the entirety of the past week or so trading below it. Earnings reports out of the US financial services sector were broadly stronger on Thursday, while the weekly initial jobless claims figure fell below the level of 300k for the first time since the start of the pandemic (294k). Instead of supporting the dollar, the data has eased concerns that the global economy could be set to experience a period of stagflation, whereby growth slows at a time when inflation is rising.

This afternoon’s US retail sales data will be another good test of the stagflation hypothesis. Economists are eyeing a modest slowdown in sales (-0.2% month-on-month), in part due to supply shortages in the auto industry. We do, however, think that it would take a relatively large downside surprise here to trigger another bout of selling in the dollar. Wednesday evening’s FOMC meeting minutes made it clear that a tapering in the Fed’s asset purchase programme is on the way this year, and even a handful of data misses on the way to the November meeting are unlikely to derail the bank’s plans. The minutes suggested that the process of tapering could even commence as soon as mid-November - even earlier than most of the market had anticipated.?

The move higher in risk currencies may merely be a consequence of profit taking following the rather aggressive rally in the dollar in the past five weeks or so. Newsflow out of the major economic areas has actually been rather scarce this week, and investors have perhaps used the relative calm to unwind some of their bullish dollar bets. We think that the euro looks particularly oversold at the moment. On the one hand, the European Central Bank has continued to stick by its dovish rhetoric, although on the other, inflation is rising and the Eurozone economy is holding up rather well. Wednesday’s industrial production data for August surprised to the upside, while there have been signs of growing inflationary pressures in the likes of Germany, where consumer prices were confirmed to have grown by more than 4% YoY in September. The upcoming ECB meeting at the end of the month will now be key. We may need to see even a modest hawkish tilt from policymakers to spare additional losses in the common currency from current levels.