Fed to decide on next dollar move

Yesterday, the trading pattern in the major USD cross rates remained unchanged. The upcoming Fed meeting and other event risk prevented any clear directional move. Around the close of the European markets, equities jumped higher on press headlines about a huge liquidity injection in China’s five biggest banks and on the Fed maintaining the ‘considerable period of time’ phrase in its statement. Equities profited most for this risk-on sentiment. EUR/USD spiked temporary to just below the 1.30 barrier. USD/JPY spiked briefly below 107, but the moves were soon reversed, even as equities kept their gains. In a daily perspective, EUR/USD and USD/JPY were little changed.

Overnight, Asian equities show quite a mixed picture. So, the region doesn’t fully join yesterday’s US equity optimism, despite the headlines (still unconfirmed) on a big PBOC liquidly operation. EUR/USD and USD/JPY have returned to familiar territory respectively in the 1.2950 and the low 107 area.

Today, the calendar contains quite some interesting eco releases. In the EMU the final CPI report will be published. In the US, the CPI, the Q2 current account and the NAHB indicator will be published. In normal circumstance, those data have market moving potential. The NAHB and the CPI still might cause some additional nervousness, especially in case of strong/higher than expected data. However, just hours before the Fed meeting, the reaction will probably be cautious. For an in depth analysis of the Fed policy decision see the fixed income part of this report. It will be a close call, but if the official Fed communication might prepare markets for further policy normalisation once asset buying is finished. If the rate projections of the individual Fed members (the dots) would suggest a still faster path of interest rate increases than currently discounted, it should be a (moderately) dollar positive. Of course several other scenarios are possible. However, even in case of an overall soft Fed, we think that the damage for the dollar could stay limited. If US eco data stay as strong as they were of late, the change in the Fed communication should come anytime soon.
Aside from the Fed policy decision, there is still a lot of other important event risk to come (T-LTRO’s, Scotland), but those issues might move temporary to the background.

From a technical point of view, USD/JPY confirmed the clearance of the key 105.44 resistance, opening the door for a new up-leg. Better US data and (anticipation on) the Fed preparing markets for a less expansive policy can still push the pair higher.

At the same time, the yen remains in the defensive as markets see a decent chance of more BOJ easing down the road. We maintain a positive bias on USD/JPY. 110.66 is the next important resistance.

The technical picture of EUR/USD deteriorated substantially after the break below the key 1.3105 level (Sept 2013 low). This level is now the new resistance that will be difficult to regain. The negative deposit rate is a structural negative for the euro. In a longer term perspective, the EUR/USD downtrend is confirmed. 1.2755/1.2662 is the next key support. A more pronounced correction (EUR/USD rebound), is an opportunity to add to EUR/USD short exposure. The euro is currently working off oversold conditions.

Reaction to labour market data distorted by referendum

Yesterday, the UK price/inflation data were published. The reference of the consensus stood a 1.5% Y/Y and 0.4% M/M and markets apparently considered the risk of a below consensus figure as sterling lost ground against the euro and the dollar in the run-up to the publication. The downside surprise didn’t occur and inflation was reported as expected. At first, the reaction of sterling was limited, but the UK currency succeeded a nice rebound later in the session.
EUR/GBP returned to the 0.7960/70 area. Cable even tested the 1.63 barrier.

Today, the context for sterling trading might be quite similar to yesterday. The UK labour market data are a very important piece of information in the BoE decision making process, but the reaction function of the (currency) market is disarranged with uncertainty on the outcome from the Scottish referendum. We see somewhat of an asymmetrical risk. It won’t be easy for sterling to regain further ground in case of a strong figure (e.g. better wage data). On the other hand, a poor report might put sterling under some pressure. The BoE minutes might be interesting too, but overall uncertainty reduced visibility on the BoE strategy going forward. So, sterling trading will continue to develop in some kind of an erratic pattern until the referendum is out of the way.

Uncertainty on the referendum after the recent opinion polls made us change our ST bias on sterling last week. There is a substantial risk that this issue will keep sterling investors side-lined until it is out of the way. We removed our sell-on-upticks bias for EUR/GBP and installed stop loss protection on GBP-longs (both against USD and EUR). We avoid sterling long exposure short-term.