The euro rallied yesterday following the ECB decision as President Lagarde highlighted that the Bank is not targeting the euro exchange rate. The British pound was the main loser among the G10 currencies, being hurt by increasing tensions between the EU and the UK, something that diminishes the chances of the two sides reaching common ground before a self-imposed October deadline.
The US dollar traded higher against most of the other G10 currencies on Thursday and during the Asian morning Friday. It recorded the most gains against GBP, and then against NOK and NZD, while it underperformed slightly against CHF and EUR. The greenback was found virtually unchanged versus AUD.
The strengthening of the US dollar and the Swiss franc suggests that the financial community traded in a risk-off fashion once again. Indeed, most major EU indices closed their Thursday session in the red, with the only exception being Italy’s FTSE MIB, which gained 0.25%. Risk aversion intensified during the US session, with Wall Street’s main indices losing on average 1.73%. The main loser was Nasdaq as investors may have decided to lock profits on tech stocks again. Firms that rallied since March lows, such as Apple Inc, Microsoft Corp and Amazon.com, fell at least 2.8%. That said, sentiment improved during the Asian session today. Although South Korea’s KOSPI is trading virtually unchanged, Japan’s Nikkei 225 and China’s Shanghai Composite are up 0.61% and 0.36% respectively.
Yesterday, the main event on the financial agenda was the ECB monetary policy decision. The Bank kept its monetary policy untouched, reiterating that they stand ready to adjust all their instruments, as appropriate, to ensure that inflation moves towards its aim in a sustained manner. Although President Lagarde said that the risks of the economic outlook remain to the downside, the Bank’s GDP projections were revised slightly higher. The inflation forecasts were unchanged for this year, slightly upgraded for 2021, and unchanged again for 2022. In the Q&A session, when asked about the euro’s latest strength, President Lagarde noted that the extent to which the euro affects prices negatively was discussed extensively, and that it must be monitored carefully. However, she highlighted that the Bank does not target the exchange rate.
Following comments by ECB chief economist Philip Lane that the EUR/USD exchange rate “does matter” for monetary policy, many investors may have been waiting a more dovish language, and this is evident by the rally in the euro after Lagarde said that the ECB is not targeting the exchange rate. However, the rally in EUR/USD did not last for long. The broader risk aversion boosted the safe-haven dollar, with the pair retreating back near to its pre-ECB levels.
Staying in the FX sphere, the British pound was, by far, the main loser among the G10 currencies, and this may have been due to increasing fears over a no-deal Brexit. Yesterday, the EU told Britain that it should urgently scrap plans to amend the withdrawal agreement, but the UK government refused to do so and instead pressed ahead with a draft law that will override key parts of the accord. As we noted on Tuesday, all these tensions lessen even further the chances of any progress being made for reaching common ground before the October deadline, something that increases the chances for a no-deal Brexit at the end of the year, when the transition period expires. In our view, this is likely to keep the pound under selling interest for a while more.
EUR/USD traded higher yesterday, following ECB President Lagarde’s comments over the exchange rate, but hit resistance at the 1.1917 barrier and then it pulled back to its pre-ECB levels. Overall, the pair continues to trade above the upside support line drawn from the low of May 14th, and thus, we would consider the near-term outlook to still be positive.
That said, in order to get confident over another round of recovery, we would like to see a break above the 1.1865 zone, marked as a resistance by the highs of September 3rd and 4th. This may pave the way for another test near the 1.1917 barrier, which if broken this time around, may allow extensions toward the psychological zone of 1.2000.
On the downside, we would like to see a dip below 1.1755, marked by Tuesday’s and Wednesday’s lows before we start examining the case of a bearish reversal. Something like that would not only drive the rate below the aforementioned upside line, but would also confirm a forthcoming lower low. The bears may then decide to target the 1.1697 level, marked by the low of August 3rd, the break of which could extend the slide towards the 1.1628 area, defined as a support by the inside swing high of July 23rd.
Cable tumbled yesterday, falling below Wednesday’s low of 1.2885, thereby confirming a forthcoming lower low. That said, the slide was stopped near the 1.2775 territory. Overall, since Monday, the pair has been trading below the prior upside line drawn from the low June 29th, while since September 1st, it’s been respecting a new downside resistance line. All these technical signs paint a negative near-term picture, in our view.
If the bears regain control soon and manage to push the action below 1.2775, we expect them to shoot for the low of July 22nd, at around 1.2642. If they don’t stop there, a break lower may see scope for more extensions, perhaps towards the 1.2527 territory, which provided decent support between July 8th and 20th.
Now, in order to abandon the bearish case, we would like to see a strong recovery back above 1.3035, a resistance defined by yesterday’s high. The rate will already be above the downside line taken from September 1st, and may initially encourage the bulls to put the 1.3143 hurdle on their radars. That level marks Monday’s low. If they are strong enough to overcome that obstacle as well, then the next stop may be the 1.3295 area, marked by an intraday swing high formed on September 4th.
During the European morning, we already got the UK monthly GDP for July, alongside the industrial and manufacturing production rates for the month. The data showed that economic activity slowed to 6.6% mom from 8.7% in June, while both the industrial and manufacturing production yoy rates, although they stayed within the negative territory, increased by more than expected. The pound barely reacted to the releases as its traders may have kept their gaze locked on the political scene, and especially developments surrounding Brexit.
Later in the day, we get the US CPIs for August. The headline rate is anticipated to have increased to +1.2% yoy from +1.0%, while the core one is expected to have held steady at +1.6% yoy. A couple of weeks ago, speaking at the Jackson Hole economic symposium, Fed Chief Powell said that the Fed will now target a 2% average inflation and put emphasis on “broad and inclusive” employment, with the shift motivated by underlying changes to the economy, including lower potential growth, persistently lower interest rates and low inflation. Although he added that the Committee is not tying itself to any particular method to define “average” inflation, this means that the Fed is willing to tolerate above 2% inflation for a while before raising interest rates, which implies extra-loose monetary policy for longer. What’s more, in the minutes of the latest FOMC gathering, it was revealed that additional accommodation may be required. Thus, taking all this into account, we doubt that a small acceleration in inflation will alter policymakers’ plans with regards to monetary policy.
We also have two speakers on today’s agenda: ECB Governing Council members Isabel Schnabel and Jens Weidmann.
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