Sterling declines only slightly after May short-squeeze

KBC Market Research Desk KBC Bank

Can USD extend its rebound?

On Wednesday, the correction on the reflation trade petered out. The (albeit modest) decline of equities halted, core yields bottomed out and so did the dollar. Later in US dealings, the dollar made further gains as Fed Chair Yellen reiterated that the US economy is nearing the Fed goals and that it would makes sense for the Fed to gradually reduce policy stimulation. At the same time, Yellen mentioned the impact of the stronger dollar. USD/JPY finished the session at 114.65 (from 112.62). EUR/USD closed the day at 1.0630 (from 1.0713).

Overnight, the rise of the dollar is a mixed factor for Asian markets. Japanese equities profit from the rise of USD/JPY, but the pair shows no follow-through gains and trades in the 114.55 area. Chinese markets show modest losses. Australian job data were OK, but close to expectations. The Aussie dollar is gaining slightly ground after yesterday's USD driven setback. AUD/USD is trading in the 0.7525 area. As is the case for most other USD cross rates, there are no follow-through gains of the dollar against the euro. EUR/USD is changing hands in the 1.0635 area.

Today, the US housing starts and permits, the jobless claims and the Philly Fed Business outlook are scheduled for release. Housing data are expected to rebound after a poor performance in November. Jobless claims hover near cycle lows and the Philly Fed is expected to soften slightly after the recent improvement (15.0 from 21.5). The data will probably only be of intraday significance for USD trading.
The focus for EUR/USD trading will be on the ECB press conference. Coming after a December meeting with many important decision, Mario Draghi should defend those decisions. He might downplay higher inflation by pointing to subdued core prices and the temporary nature of an energy shock. So, we expect the ECB president to maintain a soft tone. That said, he will receive questions on higher inflation and on recent good eco data. If he would acknowledge some progress, it might push European yields and the euro higher. This is not our preferred, but a risk scenario. In-day-to-day perspective, the dollar bottomed out, but this morning's USD momentum is a bit disappointing. So, we stay neutral on EUR/USD (ECB risks). The base/upside in USD/JPY is maybe a bit more solid.

Global context: Two weeks ago, EUR/USD touched a multi-year low (1.0341).
After the Trump rally, plenty of good USD news is discounted. Interest rate differentials between the dollar and the euro narrowed (correction), causing a dollar correction. Longer-term, the absolute interest rate support should provide a USD floor if US data remain good and as long as there are no profound doubts on Trump's pro-growth policy. A buy USD on dips strategy remains preferred.
EUR/USD traded temporary above the 1.0670/85 resistance, but no sustained break occurred. A return north of 1.0874 would question the USD positive momentum. On the downside, EUR/USD 1.0341 is the first key support. USD/JPY is trading well off post-Trump highs (118.60/66). Yesterday', the pair rebounded, suggesting a bottoming out process, but the jury is still out. We look out whether the 112.61 correction low will hold. 111.16 marks the 38% retracement of the 99.02/118.66 rally and might be a tough support. An equity correction or a further decline in core bond yields might be short-term negatives for USD/JPY.

Sterling declines only slightly after May short-squeeze

Yesterday, sterling had to look for a new equilibrium after Tuesday's post-May short squeeze. EUR/GBP hovered in a sideways range in the 0.8645/90 area early in Europe. The UK labour data were mixed, but the rise in wage growth (2.8% Y/Y) was slightly above consensus. The positive impact on sterling was limited and short-lived. Sterling nevertheless maintained quite a substantial part of its post-May gains. EUR/GBP filled offers just north of 0.87, but closed the session at 0.8670 (from 0.8629). Cable finished the day at 1.2261, but part of this decline was due to USD strength.

Overnight, the RICS house price balance softened to 24% from 29%. Later today, there are no important UK eco data. So, sterling trading will be driven by global factors and by Brexit headlines.

Yesterday, sterling corrected slightly lower, but the move was limited given the fact that PM May hinted on a hard Brexit which was usually a negative for sterling. Despite yesterday's price action, we still don't see a big case for a sustained further rebound of sterling. We look to sell sterling into strength as long as there is no clear indication that the BoE will take action to fight rising inflation.
EUR/GBP 0.8579 marks the 50% retracement of the 0.8304/0.8854 rebound.
EUR/GBP 0.8515 is the 62% retracement level with a correction low coming in at 0.8451. This 0.8515/0.8451 area should provide a strong support.

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KBC Market Research Desk

KBC Bank

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