On Monday, the dollar extended its comeback against the euro that started on Friday as the US payrolls report and some Fed comments fuelled speculation that the Fed might raise interest rates sooner than expected. EUR/USD traded close to the 1.40 level in Asia, but a new selling wave kicked in after the start of European trading. Just before noon, the euro decline accelerated as S&P cut the credit rating from Ireland to AA. EUR/USD reached intra-day lows just above the 1.38 mark. The German factory orders (0.0% M/M and -37.1 Y/Y) came in close to expectations and had no impact on trading. Despite the change in global sentiment after the publication of Friday’s payrolls report, the intra-day correlation between stocks and EUR/USD was still quite high. US stocks initially joined the decline of the European indices, but a late session rally also helped EUR/USD to regain part of the earlier losses. EUR/USD closed the session at 1.3900, compared to 1.3968 on Friday.
Today, the US eco calendar only contains some second tier releases (the business inventories might get some market attention). In Germany, the industrial production data for the month of April are scheduled for release. Later in the session the US Treasury will auction $35B of 3 year bonds. Given the change in sentiment on the interest rate markets, it will be interesting to see how well this auction will be accepted by markets and whether it will have any impact on the US dollar.
Over the previous weeks, market sentiment was dollar negative and the euro took profit from improved global risk appetite. On top of that, there was a lot of uncertainty whether the Fed will raise its program of asset purchases (including Treasuries) and markets grew also more concerned on the fiscal situation in the US. Yesterday, we already suggested that something might have changed since last week’s payrolls report. Until now, the swings in risk appetite were the most dominant factor for trading on almost all markets. After the payrolls, markets might shift their attention to the pace of the recovery in the US and its potential impact on the Fed policy. This brings the market focus more to the developments on the interest rate markets. It is a bit too early to say that from now the fate of the dollar will depend on (the rise) in US shortterm interest rates. Nevertheless, we wouldn’t be surprised to see the dollar gaining ground on good US eco data (and further speculation that the Fed will have to raise rates sooner than expected). After the quotes of Fed’s Lockhart on Friday, we will take a very close look at the signals that will come from the Fed. If the Fed is indeed considering raising rates much sooner than markets anticipated until now, this would make the picture less dollar negative.
Until last week we had a euro positive/dollar negative bias. We think that Friday’s developments at least warrant some caution for our strategy. So, we changed our EUR/USD bias from positive to neutral. There are not many high profile (US) data on the calendar this week, but for example the reaction to the US retail sales (Thursday) could be interesting to see whether markets have indeed adopted a different way of reacting. Of course, the link between the dollar and short-term US interest rates still shouldn’t be on-to one. In this respect, it will be interesting to see the dollar reaction in case of higher yields that are, for example, the result of a failed auction.
Looking at the technical charts, the LT outlook remains euro constructive as long as the EUR/USD pair stays above 1.3739 (Previous reaction high). However, the forceful correction that started on Friday is a negative for the short-term momentum in this pair. The pair dropped below ST high at 1.4051 and below the MTMA (today at 1.4033). So, we have the impression that the topside in EUR/USD is becoming more difficult. For now, we expect some consolidation in the 1.3739/1.4338 trading range. A break below this range bottom could be indication that the ST USD sentiment is improving.
On Monday, USD/JPY was traded in a narrow sideways trading pattern 98.20 and 98.80. In this respect, USD/JPY decoupled from most other major cross rates as the dollar still managed to record some follow-through gains against the likes of the euro and the Aussie dollar. Of course, in the recent past, the losses in USD/JPY have been less compared to those in some other dollar cross rates. USD/JPY closed the session at 98.41, compared to 98.64 on Friday evening.
Overnight, Asian stock markets are in negative territory and this gives the yen some support this morning. The Japanese leading/coincident indictors show signs that the economic decline is slowing, but at least for now the improvement is far from spectacular. According to press articles, Japan will delay plans to reach a primary budget surplus by 10 years. At least for now, this is not really a big issue for the currency markets.
Global context. Over the previous weeks, USD/JPY developed a sideways trading pattern between 101.40 and 93.86/54 (May low/March low). The ‘traditional link’ between USD/JPY and the performance of global stock markets/risk appetite was no longer as tight is it used to be some time ago. Global dollar weakness was the name of the game, even as the dollar losses in this cross rates were rather limited. USD/JPY came close to the key 93.54 range bottom, but a break didn’t occur probably as markets fear Japanese (verbal) action in case of additional yen gains. Friday’s jump in the dollar also propelled USD/JPY higher in the medium term trading range. Higher short-term US interest rates could also be a support for the dollar against the yen. Yesterday’s price action was a bit disappointing, but we maintain a buy-on-dips approach in this pair. A break above the 99.80 May high might open the way for a retest of the 101.44 range top.
On Monday, sterling was under some pressure early in the session on lingering political uncertainty on the fate of PM Brown’s government after the election defeat last weekend. However, the sterling losses were very limited both against the dollar and the euro. Even more, sterling even succeeded quite a decent comeback later in the session. Cable closed the session in positive territory while the euro was not able to recoup the earlier losses. This move pushed EUR/GBP lower again and the pair close the session at 0.8660, compared to 0.8740 on Friday evening. There were was no high profile news to support this move, but the least one can say is that underlying market sentiment remains quite constructive.
Overnight BRC like-for-like retail sales dropped 0.8% Y/Y in May (total sales were up 0.8%) This was a slightly disappointing figure. On the other hand, the RICS house price balance improved from -58.70% to -44.1%. According to this indicator UK housing prices in May fell at the slowest pace in 18 months.
Recently, we were a bit surprised by the force of the rebound in sterling. In a longterm perspective sterling is probably undervalued against the euro, but we considered it too early to bet on a sustained sterling rebound. We saw the aggressive BoE QE policy (even extended at the previous BoE meeting) as a reason to stay cautious on sterling (for a similar reason we stayed dollar skeptic). We don’t see any change in the UK monetary policy assessment, but as we give much weight to the technical charts in our tactical approach, we couldn’t do anything else but drawing conclusions as EUR/GBP fell below the key 0.8637 level. This move forced us to leave our longstanding buy-on-dips approach and turn to a more neutral approach vis-à-vis the UK currency. We don’t expect a swift and forceful break lower in EUR/GBP. Nevertheless, the (albeit temporary) break below this key support level is an important signal/ confirmation that something is changing in market sentiment towards the UK currency. At the end of last week, the sterling picture was again clouded by the political turmoil. However, the damage for sterling was again limited and short-lived. For now we keep a neutral bias for this pair as we expect some consolidation in the 0.8576/0.9000 range. Nevertheless, the day-to-day momentum remains sterling constructive. The pair needs to regain the 0.8867 reaction high in a sustainable way to call off the ST downward momentum.
