FX Focus: The data that could cut odds of US rate hike

Foreign exchange analyst Rajan Dhall runs through the big issues that will drive the major currency pairs this week.

We are in (what we hope) is the final week of summer trading, which has been relatively volatile given some of the events materialising from global trade tensions exacerbated by diplomatic spats with the US.  The tariff wars have added a strong dose of uncertainty to the foreign exchange market, benefitting the US dollar (USD) over all other traditional safe-haven assets, but there are signs of a re-adjustment in process near term.  

For a number of weeks now, we have warned of the leveraged positioning in USD longs which are stretched to extremes once again, in what is a common theme in modern day markets once a trend seems to have been identified.  

We saw this at the start of year with the euro (EUR) which saw 1.2500-plus trading against the greenback despite veiled warnings from the European Central Bank (ECB) that growth and inflation targets were predicated on levels below the 1.2000 mark.  

More recently, President Trump has been criticising what he sees as currency manipulation which has led to competitive advantages in trade. This is not the first time this has been pointed out by the verbose president, who also spoke of his disapproval of the Fed's rate hike cycle which he sees in contrast to government plans to stock economic well-being.  

The Fed has since tried to distance itself from his comments to underline their independence, and markets seem to have little influenced by the president's interjection. The September rate-setting meeting is expected to produce a 25 basis-point (bp) hike (odds just shy of 95%), while December is also on the table, but expectations here are in the balance.  

Indeed, a fourth rate hike this year may be a little less certain as some believe after Fed chair Jerome Powell spoke at Jackson Hole last week.  While Powell maintained that gradual rate hikes are still the way to go, he offered a little more commitment to the data which was needed to back higher rates.  This instilled more judgement from the market which has continued to rein in the bullish tone that’s carried the dollar index (DXY) up to levels a little shy of 97.0. 

Past performance is not a guide to future performance

Later this week we will get a possible revision to Q2 GDP, which is still expected to come in around the 4% mark, so this is unlikely to change sentiment.  On Thursday, however, we get core PCE for July, and any hint of softening could see odds of a fourth rate hike trimmed a little. That could also weigh on the USD, though at this stage we do not expect the USD recovery to be dismantled, rather tempered.  This points to a period of range trading where the highs have identified for now.  

Some of the regional data - Philly Fed and Kansas City - have been much softer than expected, so there is reason to believe higher rates and a higher USD - tightening conditions - may be starting to impact. Trade figures are the ones to watch as a result. 

EUR/USD leads the way in USD performance and we saw 1.1300 tested by firmly held a little over a week ago. Just below here we saw key levels in and around 1.1285, which represent breakout points which led to the move up into the 1.1500-1.2500 area.  

A significant breakdown below 1.1300-1.1285 would suggest we test back to levels around 1.0500-1.0600 over the longer term, but, as above, we expect traders holding off making this decision, especially once liquidity improves from Sept onwards. 

Past performance is not a guide to future performance

From the eurozone perspective, one would expect the lower exchange rate to offer some tailwind to economic activity.  At the start of the week, the IFO survey in Germany saw the indices pick up better than expected, though there is plenty of uncertainty from potential US trade barriers which have German manufacturers looking on with concern for now. Trump and Chancellor Merkel have agreed to step up trade talks to resolve this, but this will take time to feed into confidence we have seen elsewhere. 

German employment, spending and inflation are also on the schedule this week, but will have limited impact, as will the EU wide sentiment indices due on Thursday.  Friday's EU CPI number for Aug is one that the market is watching with a lower EUR rate vs the USD, though as ECB president Draghi has noted, the core rate needs to pick up more to breed confidence in improving price stability. 

We still expected 1.1750-1.1800 to contain EUR/USD gains over the near term, but with heavy USD (long) positioning, any breach of the 1.1800-50 area could set off a short squeeze which could see 1.2000 reclaimed if only on a temporary basis. 

At the start of the week, EUR/GBP buying has been a key driver, but with Cable also pushing up, it is matched by USD moderation which has also seen the USD/CHF (Swiss franc) rate dipping under 0.9800 as EUR/CHF eyes the upper 1.1400's. 

In the UK, there seems to be little point looking past the Brexit scenario which is becoming murkier by the day.  Not helped by constant warnings that a no deal outcome is more likely, the pound (GBP) is being pressured as the talks are ongoing. Hopes of a deal by October have slipped, but both sides continue to try and find agreement by November, so hope remains and it is not a complete GBP washout as some were perhaps expecting.  

The EUR/GBP rise has been pretty orderly, albeit taking out some key levels above 0.8900 and 0.9040.  Calls for a potential move to parity have been rising, but there’s a sense that this will require a EUR/USD move in kind which would perhaps have to return to 1.2500 to make this happen. 

Given fair value for EUR/USD is closer to 1.2500 and Cable 1.4000, this puts EUR/GBP inside 0.8900-0.9000, but adding a Brexit premium of 9% (seen at the height of the post-referendum panic), suggests a possible move to new highs closer to 0.9400-0.9500 as more realistic - not that realistic matters much when pure sentiment dictates play.  

Little in the way of UK data to divert attention this week. 

Past performance is not a guide to future performance

Plenty of data out of Japan this week, though the Bank of Japan (BoJ) has already released its CPI measure which is 0.5% at least measure, up a tenth from the previous reading. The national government figures - released last week - came in at 0.9% for July, but with the core rate was unchanged at 0.8%. 

Few can see past the BoJ changing their stance on asset purchases despite suggestions of stealth tapering.  Allowing Japanese government bond (JGB) yields to move in a slightly wider 20bp range does not seem to have altered domestic demand for yield outside of Japan, so for now, spot and cross Japanese yen (JPY) rates will continue to feed off the stockmarkets.  

Data to come includes, household confidence, retail sales, unemployment and industrial production, and only a strong rise in all metrics concurrently will prompt the market to sit up and take notice.  

USD/JPY is refusing to bow to any near-term pullback in the USD, and continues to try and form a base above the 110.00 level.  110.20-109.90 is an area which is commonly recognised as support, and the failed dip under this level recently looks to have strengthened the resolve to form this as a platform for higher levels.  

Given the USD is softening elsewhere, this has propelled the cross rates higher across the board, with EUR/JPY leading the way and now testing onto and above 130.00.

Past performance is not a guide to future performance