On Thursday, the dollar at first managed to eke out some modest gains against the euro following its decline to a new 14 month low on Wednesday. Equity weakness and thus risk aversion was the driver behind the dollar rise, but the correction was modest and without longer-lasting significance. Indeed, EUR/USD bottomed out in late morning European trading and moved higher for the remainder of the session, setting a new ST high at 1.5061 late in the US session, before closing at 1.5029, marginally up from 1.5016 on Wednesday. Overnight, an attempt to break higher failed, leaving the pair currently little changed at 1.5030. The intra-day price action, especially in the US session showed a very close correlation with equities. The eco data, higher US initial claims, strong leading indicators and unexpected drop in house prices (in August) had no impact. The dollar remained under pressure because of underlying fundamental reasons (see below). After closure, Chicago Fed Evans said the Fed is concentrating on keeping the economy on track and is in no rush to pull back its extensive support measures: “the exit policy is not our first order concern, at the moment, it is policy accommodation”. It is this very loose monetary policy stance, the most extreme of all central banks, that is a main reason behind dollar weakness. As long as no signals appear that this policy will be tightened, the dollar will have difficulties to regain strength in a sustainable way.
Later today, Fed chairman Bernanke and vice chairman Kohn will speak at the Boston economic conference. The former speaks on financial regulation and supervision, the latter on the international perspective on the financial crisis. It is de facto the last opportunity for the Fed to influence market’s expectations for the early November FOMC meeting. However, we don’t expect this to happen. The FOMC will probably be happy by the current stance of the financial healing and the economic recovery, and therefore Evans comments might represent majority thinking inside the FOMC. There is no need to change track at this juncture. This means that a sustained dollar rise isn’t likely, even if corrections remain of course a fact of life in markets. This will add to the nervousness in European circles with the risk of some euro negative comments from the ECB becoming more likely.
Today, the calendar is interesting and contains the October EMU PMI’s & German IFO and the US Existing Home, besides speeches of some Fed governors and ECB Weber. Both the EMU PMI’s and German IFO might give us a timely indication of the stance of the recovery. Markets are looking for a slight improvement in both the PMI’s, but we believe that the risks might be on the upside of expectations as both French and Belgian business confidence yesterday, came out better than expected. In Germany, also the re-election of Chancellor Merkel might have had a positive impact on German business confidence. In August, US existing home sales disappointed, showing the first (unexpected) decline in five months. For September, the consensus is looking for an increase by 4.9% M/M, to a total number of 5.35M. We have no clear view on the risks as the earlier released housing data surprised on the downside of expectations which might be due to the expiration of the government’s support for the US housing market, but last month’s pending home sales surprised on the upside of expectations. The reaction of EUR/USD on these data might once more go through its impact on equities, which means that strong data might be euro positive and weak data dollar positive, regardless whether these concern the European or US economy.
Global context: recently, the swings in risk appetite/risk aversion were the drivers on the currency markets. Improving investor sentiment towards risk is still considered a good reason to sell the US dollar. On top of that, in this low yield environment, the dollar has become (or is at least perceived to have become) the preferred currency to fund carry-trade deals. Lingering uncertainty on the huge US financing needs, some international debate on the status of the dollar and the Fed’s intention to run an expansionary monetary policy for a prolonged period of time offer additional ammunition for carry traders to use the dollar rather than other currencies. This has put the dollar in a vulnerable position. We stay dollar skeptical as long as we don’t get a clear signal that the Fed is coming closer to scale down its stimulating monetary policy (see higher). Nevertheless, the ongoing building up of USD short positions at some point will trigger a ST correction (cf. the price action in sterling last week). Such a correction most probably will occur in step with the stock markets. In this respect, the inability to clear the 1100 level (S&P) recently may be a signal that such a correction is approaching, even if yesterday’s price action certainly doesn’t underpin that expectation.
Looking at the (technical) charts, the break of EUR/USD above the range top at 1.4438/48 and above the 1.4719 (Dec high) improved the picture, but the move continued to develop in a rather gradual way. Nevertheless, the corrections are very limited, too. However, as we have reached our long-standing technical target of 1.5021 (2nd target double bottom of 1.3739), we are more cautious on the ST upside potential in the pair and advice partial profit taking on standing EUR/USD long positions. We wait for a correction to (re)establish EUR/USD long exposure.
On Thursday, USD/JPY gently moved higher without much momentum. There is very little strong news or eco data behind the moves. The yen is gradually taking over the role of the dollar as the weakest currency, following strength in previous months. The general feeling is that the yen has strengthened too much in previous months, something not in line with the weak Japanese fundamentals. The trade figures and warnings like those of Nissan chief Ghosn that firms will transfer production to other countries feed that feeling. In this respect, speculation that the BOJ may scrap its corporate finance support programs, when it meets next week, in fact a yen positive feature, albeit a minor one, we admit, is having no effect of the yen. In the same vein, a government employment package that would create 100 000 new jobs generated no reaction.
Intra-day, USD/JPY moved from about 91.00 to a high of 91.71, before closing at 91.30, eking out a small daily gain. Overnight, the pair was upward oriented trading again near 91.71.
Global context: USD/JPY reached a reaction high in the 97.80 area early August. Despite positive global investor sentiment, the dollar could not hold on to its gains against the yen. The link between USD/JPY and global investor risk aversion/risk appetite became less tight and sometimes it even reversed. The dollar (and not the yen) was said to have become the preferred funding currency for carry trades. So, the price action in USD/JPY more or less joined the global dollar trend (decline). The long-term trend obviously remains USD/JPY negative. However, recently, we turned more cautious on USD/JPY shorts on technical considerations. On top of that, the change in talk from the Japanese authorities also slowed the ascent of the yen. So, the situation in USD/JPY has become a bit paralysed. Recently, we indicated that we were looking to sell into a more pronounced up-tick, hopefully in the 92/93 area. We keep a wait-and-see approach and still hope to get the opportunity to resell higher, something that has become more likely.
On Thursday, sterling initially gained some ground on the euro as the short covering avalanche apparently wasn’t completely exhausted. However, the move lacked momentum, as traders were cautious ahead of the release of the September retail sales. So EUR/GBP slid from an opening level of 0.9040 to an intra-day low of 0.90127. The sales were flat on the month, which was disappointing as compared to the consensus estimate (0.5% M/M). Sterling rapidly lost ground and EUR/GBP rose to 0.9069, but the up-move lacked conviction and the pair slid gradually lower again to close the session little changed at 0.90438 compared to 0.90407 previously.
The report after all didn’t bring a clear message about economic growth going forward and thus also its significance from a monetary policy point of view was uncertain. MPC member Tucker reportedly said that the BoE could extend its QE if needed, which was also cited by traders as a reason for temporary euro strength, but we wouldn’t draw too much conclusions from it and think it was of minor importance behind the intra-day price action. On Wednesday, sterling had rallied after the Minutes as some observers deduced that the BoE was unlikely to boost its QE.
Today’s Q3 GDP release will get more attention. The market expects a 0.2% Q/Q and -4.6% Y/Y outcome, which would mean the UK economy is (technically) out of recession. In Q2, GDP shrunk by 0.8% Q/Q and 5.6% Y/Y. A strong figure might give sterling some additional strength, but following a violent short covering move in previous days, we suspect that the market positioning is again more neutral, making reactions probably more muted. Overnight EUR/GBP dropped to 0.9023, which might mean that some traders are pre-positioning for a stronger GDP report, but the drop occurred in early Asian trade and looks a bit suspicious to us. The EUR/GBP 0.8984 (Sept 23 low) support level comes in the picture and maybe the catalyst level for trading today.
EUR/GBP to extensively test the 0.9080 support area. The break of this level, however, occurred after the publication of the Minutes of the October BoE MPC meeting. The bank took notice of some improvement both in the worldwide economic data and in markets. The text also mentioned the decline of sterling. There was little new in the Minutes, but some observers correctly noted that in contrast to September the more dovish MPC members didn’t re-state there preference for more QE, making such an expansion of the QE unlikely. We are not sure whether this omission has been intentionally and whether some importance should be given to it. We’ll probably only know at the next MPC meeting in early November. Whatever the case, without any doubt, it bolstered the sterling, under the assumption that it might have been the very first, shy turn towards a less easy policy. For now, we are a bit reluctant to read a high profile U-turn in the October Minutes. However, for the (currency) market it was enough to trigger a next GBP short squeeze. EUR/GBP left the 0.9080 area behind and tested the 0.90 area in US trading. So, the 0.8984 (Sept 23 low) comes in the picture. Later in the session some profit taking occurred and EUR/GBP recouped part of the losses, leaving the pair at 0.90407 in the close, down from 0.9122 on Tuesday evening. Overnight, sterling regained some strength, but currently the pair changes hands near yesterday’s closing levels.
Global context: Since early August, sterling sentiment deteriorated again. The BoE decision in August to raise the asset purchase program to £175B and Governor King’s call for an even greater effort indicated that the Bank intended to maintain a loose policy for a prolonged period of time. This triggered a new sterling selling wave. At the September meeting, the BoE took no additional policy steps. Nevertheless, the (monetary) picture stays sterling negative and more BoE talk on the positive effects of sterling weakness for the UK economy reinforced investors’ feeling that the BoE was happy with the course of events. We have a long-standing sterling negative view and don’t feel any need to change it. However, recently we advocated some caution on the recent steep EUR/GBP rise. We were looking to add/reinstall EUR/GBP long positions around first important support area at 0.9080. A break below the latter suggests that the short-term negative bias toward sterling is changing, which isn’t our preferred scenario though. We are cautious to change track, as the Minutes are insufficient clear to us to deduct that the MPC has completely left the idea of extra QE purchases. For now we maintain a wait-and see approach and look out whether the correction has run its course. The 0.8984 support level is the next point of reference.
