Soft Fed discounted after recent USD weakness?

KBC Market Research Desk KBC Bank

EUR/USD was well bid yesterday. The couple eked out gains as investors avoided excessive USD long exposure ahead of a cautious expected Fed meeting (tonight). At the same time, euro buying found support in a positive surprise of Germany's ZEW confidence (expectations component) and an overall constructive risk climate. However, the latter was shaken by conflicting reports on trade later on. Some US officials are concerned China is resisting US demands. China also stepped back from earlier trade promises it made, saying they do so because there haven't been any assurances from the US that tariffs would be lift. The EUR/USD uptrend stalled. The pair closed at 1.1352 (from 1.1337). USD/JPY closed a choppy trading session stable at 111.39.

Asian markets are trading mixed this morning. Chinese equities underperform following the trade reports. The Chinese yuan opened slighty lower but has recovered most losses soon after. The Aussie (AUD/USD 0.708) similarly staged a turnaround after slipping as the RBA said that risks to financial stability have become "elevated". Minutes of the BoJ showed disagreement among its members over monetary easing. One member said the BoJ should avoid market expectations of no change in policy to be fixed to "an excessive degree". USD/JPY is trading at 111.55, up from 111.40.

Today's economic calendar is extremely thin. The Fed meeting tonight will have market's undivided attention. We expect the central bank to reduce its anticipated 2019 rate hikes from 2 to 1 with no hikes penciled in for 2020 (vs. 1 in December). Powell will probably also announce the end of the balance sheet run-off by the end of the year. We believe the dollar at the current levels has discounted a soft Fed. That might result in sideways EUR/USD trading ahead of the Fed with some risks of profittaking afterwards. More so because any further sustained rebound in EUR/USD probably needs better EMU data first.

Sterling entered calmer waters yesterday after the UK's Speaker of the House thwarted May's brexit strategy. Markets are now awaiting the PM's next steps which would consist of asking the EU to extend the deadline. Reports suggest she seeks at minimum a 3m extension. It is unclear however how the EU will respond at the summit tomorrow. We don't expect the brexit process to be clarified soon and stay cautious on sterling. The 0.8490/0.85 area might become a ST floor for EUR/GBP.

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KBC Market Research Desk

KBC Bank

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