On Tuesday, the dollar painted again a mixed and diffuse picture. USD/JPY traded according to the usual risk-on/risk-off reaction function. A decline due to equity weakness in Asia and at the start of European trading slowed later on as US risk sentiment improved slightly. USD/JPY closed the session at 119.06 (from 119.40 on Monday). EUR/USD remained captured in a clear short-term downtrend. A soft EMU inflation reading reinforced the move, but the trend was already in place before the release. EUR/USD drifted further below the 1.0780 support area and closed the session at 1.0748 (from 1.0831).

Overnight, Asian markets stay in risk-off modus. The Caixin China services PMI dropped to 50.2 from 51.2 and the composite index fell below 50 (49.4), suggesting a further cooling of the Chinese economy. The PBOC lowered the fixing of the yuan to the lowest level since April 2011. USD/CNY trades currently in 6.5465 area. The spread between the on-shore and the off-shore yuan widened further this morning. China is devaluing its currency and putting pressure on other economies in the region, while it weighs on regional (equity) sentiment too. In addition, the region was confronted with another source of tension, North Korea conducted a nuclear test. Losses in Asian equity indices are modest and trading orderly. China outperforms on the weaker yuan, while Japan underperforms with USD/JPY extending its risk-off driven downtrend and trading in the 118.70 area. EUR/USD is little changed in the 1.0745/50 area.

Later today, the eco calendar is well-filled, especially in the US with the ADP employment report, trade balance, non-manufacturing ISM, factory orders and the Fed’s FOMC minutes. In the euro zone, the final reading of the December services PMI will be released. We see slight upward risks versus the consensus for ADP job growth and for the Non-manufacturing ISM (see fixed income part of this report). The final EMU services PMI might be revised marginally higher.
However, it is doubtful that such an outcome will change sentiment on markets. It looks that sentiment might stay risk off as markets focus economic uncertainty in China and its impact on the global economy. This context remains negative for USD/JPY. Decent US eco data might slow the decline but sentiment on risk should improve to put a floor under USD/JPY. It’s too early to make this call now (US equity futures show losses of about 0.75%)

We are still a bit puzzled on the reaction function of EUR/USD. For now, the risk-off sentiment didn’t really narrow the US-German rate differentials. This is keeping the dollar well supported against the euro. However, this pattern might change if the risk sentiment remains really negative or even deteriorates further. In such a scenario, markets might scale back fed rate hike expectations. In this context we’re not keen to jump on the recent EUR/USD decline even as the technical picture of EUR/USD turned negative after the break below 1.08 and as we are rather positive on the dollar longer term. However, the reason for the EUR/USD decline occurred for the ‘wrong reason’ (risk-off rather than decent UD eco data).We still look for a rebound higher to sell EUR/USD (e.g closer to the 1.10/1.11 area).

From a technical point of view, EUR/USD failed to regain important resistance (previous range bottom/break down at 1.1087 and the 62% retracement from the October high at 1.1124) after the December ECB policy meeting and it will be tough to break. Yesterday, EUR/USD dropped below 1.0796 (07 Dec low), which improves the ST technical picture for the dollar. Next support is at 1.0650 (76% retracement off 1.0524/1.1060) and at 1.0524. The technical picture/short term trend are quite obvious. However, we are reluctant to jump on this break as the fundamentals don’t fit (cf. supra). The picture for USD/JPY (below 120).
The 118.07 (15 Oct low) and 116.18 (August low) levels are next supports.


Cable extends downtrend. GBP/EUR rebounds

On Tuesday, sterling showed a similar diffuse picture as the US dollar. Sterling continued to fight an uphill battle against a (remarkably) strong dollar. Cable finally set a new short-term low (1.4648). At the same time, sterling regained ground against the euro as the correlation between EUR/USD and EUR/GBP came again in play. Monday’s rejected test of the 0.74/0.7425 area triggered some scaling back of EUR/GBP longs. The UK PMI of the construction sector rebounded more than expected from 55.3 to 57.8 but global factors/technical considerations prevailed. Cable closed the session at 1.4676 (from 1.4716). This is in the first place due to dollar strength. EUR/GBP experienced a material setback but we consider this in the first place euro weakness. The pair closed the session at 0.7324 (from 0.7359)

This morning, BRC shop prices were reported at -2.0% Y/Y (from -2.1%). Both cable (1.4655 area) and EUR/GBP (0.7325 area) are trading near recent lows.
Today, the UK services PMI will be published. A slight decline from 55.9 to 55.6 is expected. We don’t have strong reasons to take different view from the consensus. Sterling (especially cable) might be slightly more sensitive to a negative surprise rather than to a positive one. Global factors and the Brexit debate remain an important factor for sterling trading. A sustained rebound of sterling will be difficult unless there are signs of progress in one of those two factors. That said, Monday’s rejected test of the 0.74 area has apparently improved the short-term momentum for sterling against the euro. 0.7424 is a first short-term resistance. Next resistance is seen at 0.7493 (Oct top).The rebound of EUR/GBP was a bit exhausted. Some further correction might be on the cards. A drop below the 0.73 area would call off the ST uptrend. The technical picture of sterling against the dollar remains fragile. The key 1.4566 2015 low comes within reach.

This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.

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