Risk-off sentiment takes its toll on dollar

On Friday, equities and commodities (especially oil) stayed under sharp downward pressure. Brent oil lost again almost 2 dollar and closed at 37.93, a new cyclical low. US equities shed about 2% and the S&P fell below previous low, painting a ST bearish double top on the charts. Initially, the impact on the dollar was mixed. USD/JPY suffered from the risk-off sentiment. At the same time the dollar performed reasonably well against the euro. The US data (retail sales and PPI) were OK, but had hardly any lasting impact on USD trading. Later in the session, risk-off sentiment intensified and became the dominant factor. US Treasuries sharply outperformed German Bunds and the 2-year (but at other maturities too) spread narrowed 5 bps. EUR/USD tested the 1.10 barrier, setting an intra-day high at 1.1032 and approaching the correction high at 1.1043, but closed just below 1.10 at 1.0990 up from 1.0945 on Thursday eve. USD/JPY closed at 121.01 from 121.56 previously, setting a new correction low. Understandingly, the commodity currencies Aussie, Kiwi, ZAR and CAD still underperformed the US dollar. Finally, the Chinese authorities continue to let their currency depreciate. USD/CNY trades now at 6.45, up for the sixth consecutive day, and the highest level since the August devaluation. The depreciation of the yuan needs to be followed closely, as it might intensify downward inflation pressure in the US and EMU, with potentially impact on monetary policy and thus on the currencies. All in all, it was a bad day for the USD against euro and yen, but given the sharp risk-off and the narrowing of the yield differentials, it could have been worse.

Overnight, Chinese retail sales, industrial production and Fixed investment (Saturday) all pointed to a stabilization of economic conditions. The Japanese Tankan data were mixed: current headline indices were ok, but outlook was below expectations and lower than in September. The PoBC said the yuan shouldn’t be measured by its moves against the dollar alone (see below for details). Chinese equities trade marginally positive, while most other Asian bourses are well in the red taking their clues from a nasty WS session on Friday. Commodities stabilize to be slightly higher, the trade-weighted dollar is marginally higher and the T-Note is lower. So, weakness in Asian bourses isn’t not enough to think it could only be a risk-off session today.

Today, the US eco-calendar empty and the EMU industrial production figures for October won’t affect trading for long, also because they are outdated. Potentially more important is the speech of Draghi at noon (and ECB Costa in late afternoon). The market reacted sharply when Draghi/ECB didn’t deliver, early December, the kind of substantial easing that had been expected. The euro appreciated about 2% on a trade weighted basis since, which is substantial. It goes against the ECB policy to push inflation higher. The weakening of the yuan will be of concern too (see higher). So, we will eagerly listen whether Draghi tries to weaken the euro and whether it succeeds. Equities and commodities remain the wildcard.

Last week, the reaction function of the dollar was not consistent at all. Initially, downside pressure on oil and subsequent nervousness on global equities, weighed on the dollar. The US currency dropped below important support against the euro and the yen. The global picture for the dollar became even more diffuse toward the end of the week. USD/JPY remained under downward pressure as did oil and global equities. At the same time, EUR/USD stabilized in the 1.09/low 1.10 area, admittedly often in in very volatile trading. Sentiment on risk is mixed this morning and the dollar damage limited. This suggests that that the downside of the dollar is well protected going into the FOMC decision. Still, we stay cautious to buy the dollar as long as risk sentiment remains fragile. In a longer term perspective, the debate has shifted to the pace of further Fed tightening after this week’s Fed meeting as the ECB is done for now. It might still take some time (and some good US eco data) for the dollar to regain further ground. However, even the ‘ECB failure’ to meet market expectations, policy divergence has probably still a role to play further down the road.

From a technical point of view, EUR/USD cleared the 38% retracement from 1.1714 to 1.0524 standing at 1.0979, making the picture again neutral . A previous range bottom/break down area comes in at 1.1087 and finally the 62% retracement from the October high at 1.1124. This might be the first two tough resistance levels going into the Fed policy decision and if broken would make the picture dollar bearish. A sustained decline below 1.08 would improve the technical picture for the dollar again. The USD consolidation at the end of last week eased the ST pressure, but more confirmation/signs of stabilisation are needed before reselling EUR/USD. USD/JPY dropped below a short-term range bottom in the 122.25 area, turning the short-term picture in this cross rate negative. An lasting improvement in risk sentiment is needed to halt this decline.

Sterling captured in technical trading.

On Friday, there were only second tier UK eco data. Trading in cable and EUR/GBP was driven by technical considerations. Cable profited from USD weakness and regained the 1.52 level, with a 1.5225 close, up from 1.5160 previously. EUR/GBP tried initially to go higher, but finally backed off and closed nearly unchanged at 0.7224.

S&P confirmed the UK AAA rating and its negative outlook. The latter is due to uncertainties about the EU referendum which represents a risk for the financial sector, exports and the wider economy. The “remain” vote is still the more likely outcome. Should sterling’s role as reserve currency diminish, the rating could be lowered. This is a slight sterling negative, even as the decision doesn’t contain much new info. However together with news HSBC is considering to move its HQ to Toronto, it might still be a negative.

Overnight, The Rightmove house prices for December accelerated to 7.4% from6.2% I November but had no market impact. EUR/GBP is still trading close to 0.7220.Around noon, BoE deputy governor Minouche speaks, but after the recently released Minutes (and meeting), we don’t think he will break new ground. This means sterling will take its clues once again from developments in the main crosses and the technicals.

Euro weakness helped sterling becoming stronger last Thursday, but after the steep losses of previous sessions, that’s not enough to become sterling positive. We first want to see real sterling strength, it’s unlikely that we’ll get it today. A sustained drop below 0.72 would be a positive, but we would remain cautious ahead of the FOMC meeting and probably also afterwards as trading will rapidly thin going towards year-end. Technically longer term, the pair is still in a broad sideways range with boundaries between 0.6938 and 0.7483.

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