The dollar rose on Friday for a second day after U.S. data showed a slowdown in inflation and a rebound in regional factory activity, reinforcing views that the Federal Reserve will keep interest rates steady.
The dollar had slid against European currencies last week, hitting a 2-1/2-month low against the euro and an 18-month low against the pound on expectations that the European Central Bank and Bank of England would keep lifting rates.
But the dollar has clawed back this week, with the economy seemingly headed for a soft landing and the Fed seen maintaining the U.S. currency’s yield advantage with its 5.25 percent rate.
With tight ranges prevailing, the drop in volatility has prompted investors to sell low-yielding currencies like the yen to fund purchases of high-yielding currencies in the carry trade.
EUR/USD has come under downside pressure as stops were triggered in Asian trading hours. The price action of the USD was disappointing yesterday following the CPI release. Headline inflation fell 0.5% and the core number edged up 0.1% in October, both below the market expectation. The y/y rate of growth for CPI slowed to 1.3% from the 2.1% in September, its slowest pace of price growth since 2002.
Core CPI eased to 2.7% from 2.9%, below market expectations. Moreover the headline Philly Fed index came broadly in line with expectations but the breakdown provided for grim reading. The key forward looking new orders index slipped to -3.7 from 13.4 the previous month, its weakest reading since April 2003. The employment balance was also particularly weak, dropping to 0.2 from 9.4. Nonetheless, EUR net long positions have jumped sharply over the past two weeks and hence position unwinding seems to be underway, according to an analysis by BNP Paribas. Also, Fed speakers Poole and Moskow continued to talk tough on inflation. Today sees the release of US housing starts. Fed’s Fisher and Pianalto speak later today as well. But we doubt that these events will have much of an impact on FX markets following yesterday’s price action. EUR/USD could see some near-term pressure before a move higher.
The euro’s outlook has been dampened by President Chirac suggesting that it would be legitimate to question how the ECB works and that France would not be alone in ECB criticism. More populism can be expected ahead of the French Presidential election in spring. Meanwhile, the Socialist Party has chosen the charismatic but populist Segolene Royal as its Presidential candidate. ECB’s Liebscher and Papademos will speak today.
Equity and EMK markets continuing to press higher suggest that there is ample liquidity looking for risk. Within this environment especially leverage accounts will not be shy to raise funds on low yielding currencies. The 1.2530 resistance level on USD/CHF needs to be watched in this respect.
A break above here would imply a move towards 1.2575 but we would not expect a break above this latter level. Although the Fed is talking tough, the market realises that there is no need to hike further. US data risks lie on the downside and hence there is potential for the USD to correct lower. In EUR/CHF terms, the pair is likely to stay well supported for now. The European yield curve remains flat and this is supportive of the currency pair.
The UK RICS house price survey rose strongly to 48% in October from an upwardly revised 46% last month against market expectations for an unchanged 45% reading. Thiswas followed by a strong retail sales report showing an increase of 0.9% in October against expectations for a rise of just 0.3%. The y/y rate accelerated to 3.9% from a downwardly revised 3.0% y/y reading in September.
Stronger data from the UK brought the recent GBPUSD decline to a halt, but the correction has proved modest. Although support at the 1.8850 area, which also coincides with the 50% retracement of the entire rally seen from the 1.8520 mid-October low, is holding, the USD is gaining ground across the board on position adjustment. In fact,
European currencies have seen a jump in net long positions over recent weeks which allow for more reason to unwind. Furthermore, the market remains nervous on GBP following more dovish comments from the BoE. Holding above the 1.8850 level is crucial to maintain the medium term bullish outlook. A break below this level would imply a deeper pullback.
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