21.07.23: Global Search for Yields Will Drive Near-Term Sterling and Euro Moves Against the Dollar
There are further hopes that China will engage in further policy stimulus in the short term.
These hopes should help underpin risk appetite in the short term which will support risk-sensitive assets. Markets will also tend to chase higher yields, especially if volatility is relatively low.
There are also expectations that the Federal Reserve will not raise interest rates beyond the July policy meeting with underlying dollar sentiment relatively weak.
A key element, however, is that potential dollar sellers need an attractive alternative currency to buy.
In this context, there are reservations over all the other major currencies.
There is also speculation that the ECB will not increase interest rates beyond July while Bank of England expectations have been scaled back.
With the Bank of Japan still in dovish mode, there are still reservations over switching away from the US currency, especially as US yields are still very high in global terms.
High US yields also increase the cost of betting against the dollar.
The narrative will change if there is convincing evidence of the global economy out-performing the US, but there has been no clear evidence of this at the present time, especially given European reservations.
The Euro-Zone is also finding it very difficult to compete against the US in most industrial sectors.
Pound US Dollar Exchange Rate Outlook
The Pound was subjected to significant selling after Thursday’s European open with further reaction to the inflation data.
The Pound to Dollar (GBP/USD) exchange rate dipped to lows below 1.2850 before stabilising.
There was a significant net recovery later in the day with a net GBP/USD recovery despite wider dollar gains.
There was a limited reassessment of the situation with UK yields recovering ground as the 2-year yield increased to near 5.00%.
Markets also expect that the Federal Reserve will not increase rates beyond July and are also more doubtful whether the ECB will continue to raise hikes in September.
In this context, there are still expectations that the Bank of England will extend rate hikes beyond the other two major central banks.
These expectations provided some net Pound support.
A slide in the latest reading for the GfK consumer confidence index will raise some fresh doubts surrounding UK spending trends, but the retail sales data was stronger than expected with a 0.7% increase for June compared to expectations of a 0.2% gain.
“The pound reacted more to the retail sales data than consumer confidence, as GBP/USD moved back to 1.29 after falling to around 1.2850 yesterday, ” said economists at Lloyds Bank in reaction to the UK data releases.
Two heavy by-election defeats for the Conservatives and one narrow win are unlikely to have an impact on financial markets.
Overall, GBP/USD is still at risk of further test of support in the 1.2850 area.
Euro (EUR) Exchange Rates Today
The Euro was unable to make headway on Thursday with further Euro to Dollar (EUR/USD) selling interest above the 1.1200 level.
Selling pressure gradually increased with lows just below 1.1120 before a slight recovery.
There are very strong expectations that the ECB will increase interest rates at next week’s policy meeting, but there is increased uncertainty over the medium-term outlook.
Overall markets are more sceptical that the central bank will tighten beyond July which has hampered the Euro.
Rabobank notes increased doubts surrounding the ECB stance.
It notes; “Up until recently market pricing indicated a very firm conviction that this meeting would also bring a 25-bps rate move. However, confidence in such a move has started to waver and it is our house view that the ECB could chose to leave rates unchanged in September.
It also has reservations over the economic outlook; “Clearly the decision made in two months’ time should depend on the tone of the economic data made between now and then. But, while core inflation remains sticky in the Eurozone, there are already plenty of signs of weakness elsewhere in the economy.”
Goven Euro-Zone doubts, Rabobank considers that EUR/USD could retreat to 1.08 on a 3-month view.
US Dollar (USD) Exchange Rates Outlook
The US Philadelphia Fed manufacturing survey remained in contraction territory for July with a marginal improvement to –13.5 from –13.7 the previous month and compared with expectations of –10.0.
There was a further decline in new and unfilled orders for the month with shipments also sliding into contraction territory for the month.
Price indices were potentially significant with prices paid increasing at a slower rate while there was a much stronger reading for prices received which suggests that companies are looking to exploit stronger pricing power in the economy.
The jobless claims data was mixed, but markets tended to focus on the inflation developments within the Philly Fed survey.
In this context, there were fears that US rates would need to stay stronger for longer which supported the dollar.
There were further warnings from China that it would prevent substantial yuan moves which will have some impact in stifling dollar buying.
The most likely outcome is relatively narrow ranges ahead of next week’s Federal Reserve policy meeting with a reluctance to sell the dollar into the decision.
Other Currencies
The Pound was under pressure on the crosses after Friday’s European open, but there was a solid rebound later in the day as UK yields moved higher.
The Pound to yen (GBP/JPY) exchange rate found support below 180.00 during Thursday and rallied to 180.70.
The Swiss franc lost ground during the day with a correction from strong gains. Earlier in the week.
The Pound to Franc (GBP/CHF) exchange rate found support above 12-week lows and rallied to 1.1160 on Friday.
The Pound to Australian dollar (GBP/AUD) exchange rate recovered from 4-week lows at 1.8850 before a recovery to 1.9000.
From lows just below 2.0500, the Pound to New Zealand dollar (GBP/NZD) exchange rate rallied to 2.0670.
The Pound to Canadian dollar (GBP/CAD) exchange rate also found support close to 1.6900 and edged higher to 1.6970.
The Day Ahead
There are no significant US data releases on Friday and the Federal Reserve will remain in a silent period ahead of next week’s policy decision.
Markets will still be on alert for any media leaks through the Wall Street Journal.
Overall moves in equity markets will be a key influence during the day.
Over the weekend, markets will be monitoring any further policy developments within China.
The Spanish general election on Sunday is unlikely to have a significant impact.
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