USD trending cautiously higher ahead of the Fed

Early on Tuesday, currency markets continued to trade lacklustre. However, record-low EMU interest rates and a better bid on the equity markets sparked livelier trading that helped the dollar to some moderate gains, both against the euro and the yen. EUR/USD set a minor new low for 2014. USD/JPY tried to regain the 102 big figure.

Overnight, Asian equities continue to build on the positive momentum that reigned of late even as the gains are limited. The dollar extends its gradual uptrend against the euro and the yen. EUR/USD is only a few ticks away from the 1.34 big figure. USD/JPY settles just north of 102. So, the dollar remains the preferred currency going into the key US eco data and the Fed policy decision.

Today, the calendar heats up with the EMU confidence data and the German July inflation data. Spain and Belgium will report Q2 growth figures too. The focus of markets will be on the German inflation data. A setback from 1.0% Y/Y to 0.8% is expected. A more pronounced decline will reactivate the debate on too low inflation and would be a euro negative. We also see downside risks for the EC confidence indicators. In the US the ADP labour market report and the Q2 GDP will be published. The ADP is expected to show a raise in private employment of 230.000. The GDP growth is expected at 3.0% annualised. For the GDP, we see downside risks. So, the data are a bid of a mixed bag for the dollar. We assume that USD traders will keep a wait-and-see mode going into the Fed meeting unless the data show a big deviation from consensus. Regarding the Fed policy decision, we don’t expect Yellen en Co to unsettle the market during the summer period. However, the market recently discounted the possibility that the Fed could already give some hints on the timing of policy normalisation. The US 2-year yield is testing the 2013 top at around 54 basis points. This rise in short-term yields also supported the dollar. If the Fed leaves its assessment completely unchanged (our preferred scenario), this could be a slightly negative for the dollar. However, with the payrolls still on the horizon, any correction will be limited. USD/JPY is more vulnerable to such a scenario than USD/EUR. If the Fed makes even a small further step toward policy normalisation, the dollar will probably get further (interest rate) support, especially against the euro.

In a longer term perspective, the gradual rise of the dollar against the euro will probably stay intact. Last week, EUR/USD dropped below the 1.3503/1.3477 support even without a clear trigger. The move fits our long term view and the pair stayed well below this level over the previous days. Even so, we stay a bit cautious and look out whether the recent strength of the dollar will ‘survive’ the Fed policy announcement and the key US data that will be published this week. Disappointing US eco data might still trigger a pause/correction on the USD currency especially after the recent run. Even so, we still see a more pronounced correction as an opportunity to add EUR/USD short exposure. The EUR/USD downtrend remains intact as long as the pair holds below the 1.3651/1.3700 area. We maintain a sell-on-upticks bias for the EUR/USD cross rate. In case of a break below 1.3400, 1.3296 is the next short-term target.

Cable drifting further south of 1.70 barrier

Yesterday trading in cable and EUR/GBP was again rather uninspiring. The UK money supply and lending data painted a mixed picture. Lending related to the housing market was higher than expected but consumer credit growth and lending to business was rather poor. There was no big reaction of sterling immediately after the publication of the data but the UK currency gradually lost some ground against the dollar and the euro later. Cable even dropped below the recent lows in the 1.6962/53 area. This was partially USD strength, but selling from cable probably put some pressure on sterling against the euro, too. EUR/GBP touched the 0.7925 area.

This morning, EUR/GBP is little changed in the 0.7910/15 area. Cable stays under pressure as the dollar remains well bid across the board.

Later today, there are no important eco data on the agenda in the UK. So trading in EUR/GBP and in cable will again be driven by the performance of the euro and the dollar. A low German inflation figure might keep the euro under pressure. Overall USD strength is weighing on cable. This move could slow in case of disappointing US eco data and/or a rather soft Fed statement. We expect EUR/GBP to hold near the 0.79 pivot. The upside remains well protected.

Recently, EUR/GBP stayed near the cycle lows and it even set a minor new low earlier last week. The UK news has been a bit more mixed recently, but the damage on sterling remained contained. Short-term, there is room for consolidation of sterling against the euro. Even so, overall euro weakness may hamper a substantial decline of sterling against the euro. So, there is no reason to go against the trend. We maintain our LT bullish view on sterling with EUR/GBP 0.7755 as a target. However, to set up new long sterling positions we maintain a sell-on-upticks tactic for EUR/GBP.