Fundamental Analysis

Currencies: Dollar Fights an Uphill Battle

Typography

The European equity sell-off ended yesterday afternoon and allowed equities to move a bit higher today. US equities take a strong start in a session devoid of eco data or key events.

The ECB cannot risk running "the economy hot" to support employment once inflation stabilizes at its target of almost 2 percent, ECB Executive Board member Benoit Coeure said. He also added that so far there is no evidence that a prolonged period of high unemployment has increased structural unemployment in the euro zone.

UK factory output rose to the highest level since 2013 in the three months to May, helped by strong exports, according to the CBI. Growth was mainly driven by mechanical engineering and chemicals. Respondents expect another increase in production in the next three months.

The EMU's adjusted current account surplus narrowed a touch in March, but continued to hover near all-time highs. The seasonally and working-day adjusted surplus eased to €34.1B euros from €37.8B a month earlier, when it was at its highest level on record for the euro zone.

For the first time since the Asian financial crisis, Indonesia's sovereign bonds are rated investment grade by all three major credit ratings agencies after S&P lifted its rating on the country's debt. The agency said it expects net government debt to stabilise near current low levels below 30%, while the budget deficit will gradually decline.

An OPEC panel reviewing scenarios for the oil producer group's meeting next week is looking at the option of deepening and extending a deal to reduce crude output, OPEC sources said, in an attempt to drain inventories and support prices. Brent crude rose further, moving above $53/barrel.

Rates

Cautious risk-on sentiment. Bonds slightly lower.

Risk aversion gradually disappeared yesterday afternoon as riskier assets, like equities, found their composure and struggled off the lows. This development continued today, albeit it at a snail's pace. Equities are going slightly higher and the safe haven core bonds ease very gradually lower. The risk sentiment remains the driver of markets and this is reflected in a strong inverse correlation between equities and bonds. There were no new revelations in the case of the Trump campaign and its links to the Russia, which explains the cautious return of equity buyers and bond sellers. No important economic reports were released. ECB Coeuré was rather hawkish in his comments (see news), but couldn't really impact the market. For some time already he is consistently, but slowly moving to the idea that the ECB cannot wait too long to make policy less accommodative. St-Louis Fed Bullard, an outspoken dove, said the Fed's projected rate path may be overly aggressive. He sees little effect on inflation if unemployment would still fall further and mentioned that inflation and inflation expectations surprise to the downside. Markets ignored him.

At the time of writing, US yields rise an insignificant 0.4 bps (2-yr) to 1.4 bps (5-yr). The German yields rise by 1.5 to 2.9 bps, steepening the curve a tad. On intra-EMU bond markets, 10-yr peripheral and semi-core yield spreads versus Germany narrowed 2 to 6 bps. The Greek parliament adopted measures that should satisfy international creditors and pave the way for a conclusion of the second bailout review and the disbursement of the next tranche of the bailout loan. The EU said it will study the laws voted carefully. It might be followed by further discussions on a credible strategy to that ensure Greece's debt is sustainable. Greek yield spreads narrowed only insignificantly.

Currencies

Dollar fights an uphill battle

Dollar weakness was the main topic on the currency markets today. Remarkably, the decline of the US currency wasn't the result of a further escalation of the Trump crisis. Risk sentiment was fairly constructive. EUR/USD set new short-term highs in the high 1.11 area. Hawkish comments from ECB's Coeure were maybe an additional support for the euro. USD/JPY drifted back to the low 111 area even as equities held up reasonably well.

Overnight, Asian equities traded slightly higher, reversing earlier losses. The immediate stress from the Trump crisis eased. The fall-out from the Brazilian political crisis on other emerging markets remained contained. However, the cautious risk-rebound was no big help for the dollar. USD/JPY didn't go anywhere and stabilized in the 111.40 area. EUR/USD held a tight range in the low 1.11 area.

There was no high profile story to guide European trading. European equities opened only cautiously higher despite a good close in the US yesterday evening, but momentum gradually improved. The improving risk sentiment hardly supported the dollar. USD/JPY gained only a few ticks and basically stabilized in the mid 111 area. At the same time the euro maintained a strong bid, with EUR/USD nearing yesterday's top (1.1172). We saw only few fundamental drivers for the euro outperformance/USD underperformance. Slightly hawkish comments from ECB Coeuré maybe played a role. The rise of oil marginally supported the dollar.

The test of the EUR/USD 1.1172 top intensified at the start of the US session and the pair finally set new short-term highs. The break was clearly dollar weaknesses as USD/JPY also struggled to prevent further losses. Intraday interest rate differentials went marginally against the dollar, but are no adequate explanation for the EUR/USD rally. Overall USD weakness was striking given the developments in other markets (especially the constructive equity sentiment). EUR/USD trades currently in the 1.1190 area. USD/JPY hovers around 111.10/20.

Cable tries to sustain north of 1.30 on USD weakness.

Sterling trading was primarily driven by the broader moves in the dollar today. As a result, EUR/GBP held a very tight sideways range in the high 0.85 area. The swings in cable were much more pronounced. Cable rebounded to the 1.2950 area at the start of European trading, after yesterday's 'mini-crash' to 1.29.The pair copied the intraday gains of EUR/USD and returned north of 1.30. There was little in the way of UK news to influence this move. The CBI order data were better than expected, but the price component of the report was slightly softer than expected. We didn't see any significant reaction of sterling. At the end of the week, we conclude that recent sterling resilience eased a bit further even as UK eco data remained solid. That said, most of the rise in EUR/GBP was EUR/USD driven. EUR/GBP trades currently at 0.8585. Cable took out the 1.30 barrier, but this was mostly due to dollar weakness, rather than anything else.

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KBC Bank
Author: KBC BankWebsite: https://www.kbc.be/dealingroom
This non-exhaustive information is based on short-term forecasts for expected developments on the financial markets. KBC Bank cannot guarantee that these forecasts will materialize and cannot be held liable in any way for direct or consequential loss arising from any use of this document or its content. The document is not intended as personalized investment advice and does not constitute a recommendation to buy, sell or hold investments described herein. Although information has been obtained from and is based upon sources KBC believes to be reliable, KBC does not guarantee the accuracy of this information, which may be incomplete or condensed. All opinions and estimates constitute a KBC judgment as of the data of the report and are subject to change without notice.
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