Soft Retail Sales and Core PPI Weigh on Dollar as Market Inclined for Taper-Lite

The softer than expected core PPI and retail sales data have sent the US dollar to new session lows. It is not that the data has changed participants' minds about next week's FOMC meeting, where the latest surveys show 2/3 expect the Fed to announce tapering. Instead it reinforces suspicions of a less aggressive slowing of asset purchase.

The 0.2% rise in August retail sales was the smallest in four months, though is in part, mitigated by the fact that the July series was revised to 0.4% from 0.2%. The component used for GDP calculations, which excludes auto, gasoline and building materials rose 0.2% after a 0.5% gain in July, which was slightly less than expected. However, it is still consistent with improvement over Q1 and Q2, perhaps as the impact of the end of the payroll saving tax holiday diminishes.

Producer prices in August were inflated by food and energy prices, without which PPI was flat. Core PPI stands at 1.1% over a year ago and this is the lowest rate of producer price inflation since June 2010. August CPI will be released next week as the FOMC begins its two-day meeting. Headline CPI is expected to slow toward 1.6% from 2.0% in July, while the core rate is seen at 1.8% (1.7% in July).

In addition to the CPI, the Fed will also see the latest industrial production figures and housing starts/permits data prior to the conclusion of its meeting. However, the high frequency data is unlikely to impact the Fed's decision making or market perceptions of it.

The euro has firmed, but has remained confined to the ranges seen on Wednesday.  If consolidative pattern is a continuation pattern, it project toward $1.35, which is consistent with our sense that almost regardless of what the Fed does next week, the markets will be disappointed:  either the dollar sells off as the market had anticipated the tapering, or the tapering is small enough not to be seen as economically significant (a $15 bln reduction would reduced the stimulus the Fed provides over the next three months to $210 bln from its current trajectory of $255 bln), though it begins a process which is important.   In addition, the Fed can do other things to drive home the message that tapering is not tightening.

Sterling remains well bid against the dollar (strongest of the major currencies).  The euro is moving through the GBP0.8400 support area.  A close below there bodes well for sterling next week.  Despite the BOE's forward guidance, the market is pricing in a BOE rate hike prior to a hike by the Federal Reserve.

The midweek dollar high against the yen, near JPY100.40 is now a big figure away.   Japanese corporate offers are thought to have helped cap the greenback, and a pullback in US yields is encouraging some short-term players to cover some short yen positions.  Support is seen between JPY98.80 and yesterday's low near JPY99.00.