EUR/USD levels justified by higher US money market rates

• EUR/USD continued to trade lower yesterday despite improved risk sentiment. The move lower in EUR/USD indicates that the cross is currently trading on whether or not the Fed will start its tapering this month. There are currently several factors that could continue to support the case for stronger dollar: (i) a possible military intervention in Syria, (ii) more US data supporting the case for a September tapering (in particular, the August employment report due on Friday could very well determine whether the Fed will initiate a downscaling of the QE programme at its FOMC meeting in September), and finally (iii) speculative positioning which according to the latest IMM data, are markedly long EUR at the moment. On the other hand, we note that US money market curve has steepened quite significantly recently and as illustrated on the left hand charts on page 3, US money market currently price in four 25bps hikes in Fed Funds rate by the end of 2015, which according to our interest rates strategists is a bit aggressive and thus still look for a near term flattening of the US money market curve. The aggressive steepening in US money market curve is also reflected in the 2Y EUR-USD swap spread which has narrowed around 6 bps over the past couple of weeks (see right hand chart on page 3). Viewed in isolation the narrowing of 2Y swap spread, according to our short term financial models , can explain nearly 1 figure decline in EUR/USD spot. Hence, the decline in EUR/USD is more or less justified by the increase in US money market rates, and in our view, near term risks appear relatively balanced.

• Swedish services PMI released this morning came out at 53.7 which was slightly lower than expected (cons: 54.2). A minor correction was expected after last month's massive surge (last 56.6, before that 44.9), and over all ,it was a good number. Note however, that the services PMI is a relatively new indicator and still has to prove itself in terms of forecasting ability. Thus market’s reaction has been very limited and the Scandi FX market will probably remain in wait-and-see mode today ahead of the Riksbank meeting tomorrow.

EMEA comment

• When we talked about stabilization in the Emerging Markets in the end of last week and this Monday, things has turned quite bad very quickly, which only proves how the sentiment towards EM is fragile and it is very premature to talk about any stabilization. Besides, the present usual risks which spark the risk aversion towards EM and that is US tapering plans, the negative risk factor such as the Syria conflict, is set to intensify. Given, that the military action towards Syria seems to moving closer, every news regarding Syria conflict pointing to military strike will have negative impact on EM. The hardest hit will be the Turkish lira but it will very likely have negative spill over to other EM countries.

• In EMEA region, the top event today is the rate decision in Poland. We expect the rate decision to be however quite a non-event as it is broadly expected that the Polish central bank (NBP) will stay on hold keeping the key policy rate on hold at 2.50%. The statement from the NBP will most likely be fairly balanced or neutral and the NBP will most likely reiterate the end of easing cycle while keeping low interest rates for fairly long.