Dollar rally exhausted?

On Wednesday, the interconnection between markets was again not easy to understand. Despite conflicting signals from other markets, the USD was apparently ripe an exhaustion move. Of late, the dollar had an overall green light and cleared several important resistance levels. The sky was the limit.
Yesterday, the unidirectional USD positioning finally took its toll. A global risk-off sentiment and a weaker than expected US manufacturing ISM provided ammunition for a USD correction. USD/JPY took the lead in the correction, but finally the dollar ceded ground across the board. USD/JPY had filled bids north of 110 early in the session, but closed the day below 109. EUR/USD was little changed in the 1.2625 area.

Overnight, the dollar remains in the defensive. Most Asian equities are in the red (China is still closed). Japan is underperforming, with USD/JPY drifting further south. The risk-off modus and the decline in core bond yields provides the perfect excuse for a correction on the dollar across the board. It is understandable to see such a risk-off USD decline in USD/JPY or EUR/USD, but the dollar is also losing ground against the likes of the Aussie and the Kiwi dollar. It looks like some repositioning was needed in a market that is too long dollar.

Later today, the calendar of eco data is only moderately interesting. The EMU PPI is expected to decline further, but the case of too low inflation was already made by the CPI earlier this week. In the US, we don’t expect the jobless claims and the factory orders to have much impact ahead of tomorrow’s payrolls.
The ECB policy meeting will be the key. The ECB will leave its policy rates unchanged, but will give more details on the programme of ABS and covered bond purchases. We assume that the (currency) market already anticipates much more ECB easing than this ABS/covered bond programme. So, the focus for currency trading will be on the Draghi’s assessment of the recent low inflation data. How big is the chance that fighting too low inflation will lead to outright QE (government bond buying) in a not that distant future. President Draghi will keep this door (all options) open, but we doubt that his commitment will be enough for a new euro down-leg right now.

Aside from the ECB meeting, the global context remains important. It’s too early to conclude that we entered a longer risk-off correction. Even so, there are plenty of obstacles (Hong Kong, Ukraine, Ebola, uncertainty on corporate earnings ahead of the earnings season….) that prevents a fast return to a risk-on sentiment. This may hamper a broader rebound of the dollar right now.

Tomorrow’s payrolls can put the US currency again in another context, but for now, we assume that the dollar rally is a bit exhausted and some consolidation/correction is likely. We maintain our LT USD positive bias, but turn more cautious short-term.

From a technical point of view, USD/JPY extended its rally after the break of the 105.44 resistance and now approaches the key 110.66 resistance, amid nervousness of Japanese authorities that the yen weakening is becoming too fast. US eco strength and expectations that the normalization of Fed policy nears supports the dollar. The yen remains on the defensive as markets see a decent chance of more BOJ easing down the road. We have a positive view on USD/JPY. There is no reason to row against the tide, but in the short-term some consolidation/correction is still possible.

The technical picture of EUR/USD deteriorated further after the break below the key 1.2662 support level (Nov 2012 low). A confirmation is still needed as the pair is again near that area this morning. Over the previous days, we indicated that we are a bit surprised by the fast pace of the EUR/USD decline.
The trend is not really questioned. Even so, it might take time for the pair to work through oversold conditions. The 1.2043/1.1877 support is the LT target.

EUR/GBP: no real test of the key 0.7755 level.

On Wednesday, EUR/GBP still hovered in the upper half of the 0.77 big figure. The pair showed some intraday swings after both the EMU PMI’s and the UK PMI were reported below consensus. Cable showed some nervous swings too, due to the poor UK PMI. However, tentative signs of dollar weakness finally put a floor for the pair. At the end of the day EUR/GBP changed hands in the high 0.77 area. So, the key 0.7755 support stays intact for now.

Overnight, BoE’s Forbes said that the effects of sterling on inflation were likely to peak at the end of this year. However, for now there is no noticeable sterling reaction to these comments.

Today, UK construction PMI will be published. A limited decline from a high level is expected (63.50 from 64.00). A negative surprise might be a slightly negative for sterling. The BOE decides on monetary policy, but no change is expected.

Of late, the rally of sterling slowed against the dollar and the euro. For now there is no clear enough sign that the BoE will have to raise rates in the first half of next year. This is capping further sterling gains for now.

Short-term, we might see a slowdown in the EUR/GBP decline as the 0.7755 support looms. Further down the road, the focus for sterling trading should return to the economic fundamentals and to the guidance from the BoE on policy normalization. After the recent rebound of sterling and the soft comments from the BoE minutes, investors are pondering the chances for further sterling gains.