Sterling awaiting the outcome of EU/UK negotiations

Dollar rebound stalls as oil declines

On Thursday, the dollar initially gained ground further against the euro as sentiment on risk remained constructive and as oil extended gains. The gains of USD/JPY were negligible as were the moves in the bond market. US data (Philly Fed, claims) were marginally better than expected, but had only a marginal impact on USD trading. Later in the session, oil even declined after high US inventory data. This decline of oil weighed on overall market sentiment and also broke the positive USD momentum. EUR/USD closed the session off the intraday lows at 1.1107 (from 1.1128). USD/JPY ended the session in the red at 113.24 (from 114.10).

Overnight, Asian equities trade mostly lower, reacting to the price action in the US yesterday evening and to the correction in the oil price. Japanese equities underperform with losses of about 1.5%. USD/JPY dropped temporarily below 113 this morning, but currently trades again in the 113.15 area. The japan all industry index declined more than expected, it was no big issue for trading on Japanese markets. The PBOC put the fixing of the yuan against the dollar slightly weaker at 6.5186. Both the CNY (currently 6.5203) and the CNY (6.5250) trade slightly weaker on a daily basis. Still yuan overnight lending rates in Hong Kong jumped sharply higher today. This might be the result of tighter liquidity due to PBOC interventions in the off-shore market. The PBOC also announced that it will raise the Reserve Requirement Ratio for banks that boosted lending too fast. In the end, the Chinese currency still trades substantially stronger in a weekly perspective. The easing in the risk-off sentiment is also a slightly negative for the dollar against the euro. EUR/USD trades currently in the 1.1115 area.

Today, the EU consumer confidence and the US CPI will be published. EU consumer confidence is expected marginally softer at -6.6 from -6.3, but we see a slight upward risk. US headline CPI is expected at -0.1% M/M and 1.3% Y/Y. Core CPI is expected at 0.2% M/M and 2.1% Y/Y. We see upside risks for both measures. If so, it could be positive for the dollar. It’s not yet a big issue for (currency) markets, but higher inflation data might cause some unease with the very ‘flat’ FF strip curve discounting the path of future Fed rate hikes. The global context will also play its role for USD trading. The decline in oil and the slight setback on the equity markets is a slightly negative for the dollar. This applies in the first place to USD/JPY. This cross rate recently struggled to profit from an improved sentiment on risk and is vulnerable even in case of a limited setback. Of late, EUR/USD was far less affected by this dynamics. So, we assume some consolidation in EUR/USD after the recent modest gains. Apparently, there is a real/substantial trigger needed to push this pair below the 1.1060/70 support. The EU/UK negotiations are outside risk, also for EUR/USD trading. A failure could also weigh on the euro. But this is not our preferred scenario.

From a technical point of view, EUR/USD broke above the 1.1060/1.1124 area (15 Dec top/62% retracement). This was USD negative. The correction high stands at 1.1376. Next important resistance kicks in at 1.1495.We see some short-term topping out process in EUR/USD with room for a correction lower in the range. USD/JPY dropped below the key 115.98 pre-BOJ low. Japanese officials warned on potential action, putting a short-term floor under the pair. Even so, it remains vulnerable if global tensions resurface. Any rally might soon run into resistance . The 115.98 previous low is a first technical resistance.

Sterling awaiting the outcome of EU/UK negotiations

On Thursday, the downside in the UK currency was protected as oil extended its gains. Mid-morning., BoE deputy Governor Cunliffe said he couldn’t see anything in the past three or four weeks to warrant the shift in UK interest rate expectations, pushing BoE rate hike expectations back to 2019. Sterling gained a few ticks after the Cunliffe headlines. Around noon, sterling extended gains as EU’s Juncker said he was confident that an anti-Brexit deal would be reached at the EU Summit. There were still headlines on pending issues around financial supervision and safeguards for London’s financial sector. However, this time, sterling traders were apparently more convinced by the positive headlines. Still, the sterling rally eased later in the session. EUR/GBP closed at 0.7747 (from 0.7786). Cable closed session at 1.4337 (from 1.4294).

Today, the UK retail sales are expected to rebound (0.7% M/M and 3.5% Y/Y) after a setback in December. We don’t have strong arguments to take a different view from the consensus. Usually, this is an important figure for sterling trading. A good figure might still be slightly positive for sterling, but the focus will be on the outcome of the EU/UK Summit. The negotiations will resume this morning. Markets are apparently positioned for a scenario that an agreement will be reached anyway. Of course, the question is whether the deal will be good enough for Cameron to go to a referendum. No deal will cause losses for sterling, but may also be a negative the euro against the likes of the yen and the dollar. We stay cautious on sterling until there is more clarity on the EU/UK negotiations as there is too much binary risk, not only on the fact of reaching an agreement but also on the content of the deal. The medium term technical picture of sterling against the euro remains negative as EUR/GBP broke above the 0.7493 Oct top. First resistance stands at EUR/GBP 0.7898. A return below EUR/GBP 0.74 would be a first indication that sterling enters calmer waters.

•  Download Full Sunrise Market Commentary Currencies