Cable Crumbles as Inflation Rumbles

Market Drivers May 16, 2017
Euro takes out 1.1000
UK Inlfation remains elevated
Nikkei 0.25% Dax -0.06%
Oil $49/bbl
Gold $1234/oz.

Europe and Asia:
GBP UK CPI 2.7% vs. 2.6%
EUR ZEW 83.9 vs. 82
EUR GDP 1.7% vs. 1.7%

North America:
USD Housing Starts/Permits 8:30
USD Industrial Production 9:15

Volatility picked up markedly in the FX market on the second trading day of the week with euro and pound going separate ways as EUR/USD broke above the key 1.1000 level once again while cable took a swan dive the wake of UK CPI data.

The EUR/USD broke through the 1.1000 resistance in midday Asia trade and never looked back rising to 1.1049 before profit-taking kicked in. There was little news on the European front with only the ZEW survey on the docket, but the pair was bid all night long on anti-dollar flows. With ECB likely to begin tapering QE in the foreseeable future and with the Fed now in doubt on its 3 rate hike path in 2017, the much vaunted monetary divergence trade between the euro and the dollar is losing some of it luster.

The decline in the euro was as much a function of fears about the Eurozone break up as it was monetary differences and now that the existential risk is gone, the pair is seeing a very solid bid as growth in the region improves and investors feel more confident about its prospects.

The euro gap is now more than three weeks old and shows all the signs of being a runaway gap as the pair now inches towards the 1.1200 level. Although the rally has been in play for nearly a month the pair is not yet overbought on either the daily or the weekly basis and last week CFTC data showed that speculators turned bullish on the currency for the first time since 2014. All of this bodes for further gains in the pair as markets rebalance their long-term views.

Meanwhile, in UK, CPI data came in hotter than expected at 2.7% versus 2.6% eyed but the news sent cable tumbling as investors feared that higher inflation rates will continue to weigh on the consumer. The Bank of England has categorically ruled out any rate hikes in the foreseeable future, so any spikes in inflation are now viewed as negative for the currency especially if UK Retail Sales continue to disappoint.

Cable has now stalled in front of the key 1.3000 figure and if it continues to drift lower giving up the 1.2800 handle it will likely have put in a near term top as investor enthusiasm for the pair continues to wane.

In US today the data is decidedly second tier and unlikely to have much impact on trade. So far the markets have been remarkably complacent, but with daily turmoil in DC and little evidence of any progress on tax reform legislation, it may be only a matter of time before the market becomes impatient and profit taking kick in. So far USDJPY has held the 113.00 support but if equities and bonds begin to wobble, FX is sure to follow and the pair could see a stronger sell-off in days ahead.