Dollar enjoys additional interest rate support

On Tuesday, the dollar continued to trade with a positive bias even as the global equity rally initially slowed in Europe There was little high profile news to guide USD trading. However, this time interest rate differentials helped the US currency. The 2-year yield spread between the US and Germany reached a new cycle high (107 bp). EUR/USD closed the session at 1.0964 (from1.1016 on Monday). USD/JPY ended the session at 120.07 from 120.76.

Overnight, Asian equity markets extended their rebound with China outperforming. The China Caixin services PMI rebounded from 50.5 to 52.0 , signalling a potential bottoming out process in this part of the Chinese economy. Chinese confidence data were also better than expected. There is seldom a one-to-one relationship between Japanese data and markets. Nevertheless, Japanese equities joined the risk-on rally in Asia, maybe supported by better data in Japan and China. USD/JPY continues to traded north of the 121 barrier. EUR/USD is holding near the recent low in the 1.0950 area.

Later today, markets will look out for the final services PMI’s in the EMU and the non-manufacturing PMI in the US. We don’t have strong reasons to take a different view from the consensus for the EMU PMI’s. Even so, this figure continues to suggest decent growth in the sector. We don’t have the impression that it will be a big issue for ECB policy. In the US, ADP labour growth is expected to slow to 180 000 from 200 000 the previous month. This remains well above recent job growth as indicated by the payrolls. The US traded deficit is expected to decline from $48 bln to $41 bln. Last but not least, the US non-manufacturing PMI is expected little changed 54.5 (from 54.4), indicating further good growth in the sector. Sentiment on risk wasn’t that bad of late and if the data meets market consensus (or if they come out better than expected), markets will consider them as supporting the case of a Fed rate hike in December. So, the odds for the dollar are to maintain the recent gains, or even extend the recent rebound. 2-yr interest rate differentials between the US and Germany are holding near the cycle highs (109 bp).

In a day-to day perspective, equities and the dollar hold remarkably strong. At some point a correction on the risk-on rally will occur and might trigger some moderate profit taking in the dollar, too. However, for now, there is no signal of such a change in sentiment yet. So, the working assumption is that the dollar can stay relatively strong going into the key US eco data (payrolls) later this week.

Over the previous two weeks; the market focus changed in favour of the dollar. At the ECB press conference, ECB Draghi surprised markets by suggesting that additional easing was forthcoming. This pushed EUR/USD below the key 1.1087/1.1105 support. Last week’s Fed policy statement ‘confirmed’ a policy divergence between the Fed and ECB, pushing EUR/USD further south in the LT consolidation pattern. 1.0819 is a first important support area. The targets of the multiple top with neckline in the 1.1087/1.1105 area stand in the low 1.07 area. Some short-term consolidation on the recent USD rally is possible, but there is no reason to fight the euro negative/USD positive tide.

EUR/GBP drifting south

Yesterday , the UK construction PMI declined slightly from 59.9 to 58.8, in line with expectations and confirming the healthy level of activity. However, as was the case after a strong UK manufacturing PMI on Monday, it didn’t help sterling much. Cable held up relatively well early in the session. The pair was dragged lower by the overall USD rebound, but recouped most of the losses towards the end of the day. Cable ended the session at 1.5421 (from 1.5417 on Monday). EUR/GBP stayed on a downward trajectory, but this was mostly due to the price performance in the US cross rates, rather than USD strength. EUR/GBP closed the session at 0.7110 from 0.7145 on Monday.

Overnight, the BRC shop prices were little changed at -1.8/% Y/Y from -1.9%.
The market reaction was limited. Later today, the focus will be on the UK services PMI. A rebound from 53.3 to 54.5 is expected. The market reaction might remain guarded ahead of tomorrow’s BoE policy decision and inflation report. Even so, an inline figure should help sterling maintain its recent gains,, especially against the euro. Looking at the broader picture, the soft tone at the ECB press conference pushed EUR/GBP again lower in the longstanding sideways range. The pair tested the 0.7196 support and the level was ‘really’ broken after the FOMC announcement. We maintain a sell-on-upticks approach for EUR/GBP. The BoE inflation report on Thursday is the next key reference from sterling trading.

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