Dollar stays well bid ahead of the ECB and the payrolls

On Wednesday, tensions on global markets eased. Sentiment on European and US equity markets improved throughout the day, giving some support for the USD currency. The US ADP report was marginally weaker than expected but it didn’t hurt the dollar. EUR/USD closed the session at 1.1227, from 1.1315 on Tuesday. USD/JPY rebounded to close the session at 120.33 (from 119.37 the previous day).

Overnight, China doesn’t create any additional volatility for trading on global markets as Chinese markets are closed. Japanese markets join the rebound of US equity markets, supported by a further weakening of the yen. USD/JPY extends its rebound is changing hands in the 120.55 area. The gains on other Asian markets are more moderate. The AUD returned to the low 0.70 area after the publication of disappointing July retail sales. However, for now there was not test of yesterday’s multi-year low (0.6982) yet. The positive risk sentiment also supports the dollar against the euro. EUR/USD is drifting in the low 1.12 area this morning. The Fed beige book painted a moderately positive picture on the US economy and might be have been a slightly positive for the dollar.

Today, the final EMU services PMI and the July retail sales will be published. A slight downward revision from the preliminary reading is possible. Retail sales are expected strong at 0.5% M/M. Even so, an upward surprise is still possible. However, with the ECB policy decision and press conference only hours away, we don’t expected a big, sustained reaction from the euro. Regarding the ECB meeting, markets will look out for the ECB staff projections on growth and inflation and for the assessment of president Draghi. The ECB projections on inflation and on growth will probably be lowered from June and the tone from Draghi will be soft. This shouldn’t be a big surprise for the markets, but still the ECB communication might be a slightly negative for the euro. In the US, the Jobless claims, the trade balance and the non-manufacturing ISM will be published. The ISM is expected to fall back from a very high 60.3 to 58.2. Maybe a slightly bigger setback is possible. This might be a slightly negative for the dollar. However, the figure will remain at a high enough level to keep the door open for a Fed rate hike. So, the negative impact on the dollar should be limited.

After yesterday’s rebound on the US markets, some consolidation might kick in ahead of tomorrow’s payrolls. So, the impact from global market sentiment on the dollar might be more limited today than it was over the previous days. We expected EUR/USD to hold near the recent lows, maybe with some slight downward pressure on the euro from the ECB press conference.

In a longer term perspective, EUR/USD broke (temporary?) beyond the 1.1534 resistance (post-ECB QE top) early last week. This level was an important reference for our LT term EUR/USD short bias, which was questioned from a technical point of view. However, the EUR/USD rally was in the first place driven by global market factors (risk-off sentiment) rather than fundamental economic US and EMU news. Despite this technical warning, we maintained the view that the economic and monetary context hasn’t changed in such a way that it calls for a big change in favour of the euro and against the dollar. That said, the risk-off logic can still pop up and trigger pockets of USD weakness. For now, we see 1.1017/1.1714 as the new trading range. Within this range, a cautious sell-on-upticks approach is favoured going into the Fed September policy meeting.

First test of EUR/GBP 0.74 rejected

Yesterday, there was no big story to tell on sterling trading. The UK construction PMI rose from 57.1 to 57.3, close to the consensus (57.5). There was no noticeable reaction on currency trading. Sterling trading was in the first place driven by technical considerations. Cable set a new correction low in the 1.5265 area as the dollar was reasonably well bid due to easing global tensions, but reversed the early losses later in the session. EUR/GBP drifted off the recent highs in the 0.7395 area (reached overnight). The pair closed the session at 0.7338, from 0.7393 on Tuesday.

Today, the UK services PMI is expected to improve slightly from 57.4 to 57.7. A figure close to/better than expected might be seen as an indication that domestic demand remains well on track. Such a scenario might help to put a floor after the recent soft spot of sterling. Yesterday, there were some tentative signs that the recent decline of sterling might be slowing. For now this is nothing more than a working hypothesis. After the recent setback of sterling quite some softness should already be discounted. Despite recent sterling weakness, we maintain the LT view that the topside in EUR/GBP is rather well protected, with important resistance in the 0.7483/0.75 area. Interest rate differentials between the euro and sterling are still substantially in favour of the UK currency. A cautious sell-on-upticks approach might be considered.