Take Interest In Further Strengthening Of The Pound

Due to the holidays, last week was a short four day week in London and as predicted, it did seem to be the calm after the storm. Recent dollar weakness managed to be contained overall, with the only discernible price action to take interest in being a further mild strengthening of the pound. This week also entails a short week, and it could possibly be another slow start before there is any true direction. The following is a round up and outlook for the majors.

USD: As mentioned above, the USD managed to contain recent weakness last week, with the US Dollar Index effectively moving sideways over the course of the week. There was some movement within individual USD crosses, but strength against the yen was balanced out by weakness to the GBP; the EUR/USD and AUD/USD simply moved sideways, holding the recent highs. One would suggest however that bias still remains against the greenback, with positive economic data all week from America not exactly being rewarded. In the earlier half of the week, much stronger retails sales (up 1.1% month on month) on the Monday and better than expected CPI (+0.2%m/m) on the Tuesday had little impact. Equally, better industrial production (and previous month’s revision) data on the Wednesday and a much improved Philly Fed manufacturing Index to 16.6 on the Thursday had little influence. In fact the only poor news from America was possibly from the housing sector, with building permits and housing starts reporting lower than forecast.

Outlook: Essentially the USD was given enough ammunition last week to reverse at least a fraction of recent losses, but this scenario didn’t unfold. Market commentators were quite open about their reasoning, highlighting the Ukraine situation dampening an advance and dovish comments from Fed Chairwoman Janet Yellen at a New York economics forum as potential causes. More overly, we believe the financial markets are simply happy to continue within current market parameters, taking stock of the quick turnaround to USD weakness seen of late. Going forward the fundamentals change very little; Federal Reserve tapering and a potential rate hike next year should strengthen the USD notably over the longer term. In the short term however, there is argument that focus with hold more with other currencies, possibly leading to a continual softening of the USD.

EUR: The single currency did very little last week, with the EUR/USD moving almost sideways and EUR/GBP dropping slightly from further GBP strength. Economic data last week from the European bloc was of the negative variety, making for more confusion as to why the USD couldn’t capitalise against the EUR. Industrial Production on the Monday reported in line with consensus, the German ZEW economic sentiment index on Tuesday softened more than expected, inflation data on the Wednesday slightly underperformed and German PPI figures on the Thursday fell flat. As we suggested last week, a further rise in the EUR/USD could be inevitable (see outlook), and level price action in that cross last week against a backdrop of stronger USD data/weak EUR data certainly supports that perspective.

Outlook: As mentioned above, the EUR/USD is possibly shaping up for another drive higher. Last week we highlighted ECB Governor Mario Draghi’s concerns over further strength in the euro, with him warning that this could trigger monetary easing tools to hold off low inflation. We also speculated that these comments could simply act as a “red rag to a bull”, almost prompting the financial markets to weaken the EUR further to test the ECB’s resolve. Although the euro moved sideways against the USD last week, whilst losing a pinch of ground to the GBP, this price action was still not really in line with the developments seen, perhaps supporting our argument. Going forward, fundamentals in America might be ignored in the short-term, with more emphasis placed on EUR strength until the ECB are forced to open up their box of tricks. The EUR/GBP could ultimately move sideways however, as the GBP gains in tandem with the EUR.

GBP: The best performer last week was the GBP once again, making decent gains against the USD and also strengthening mildly against the EUR. Whilst key UK inflation data on the Tuesday was in line with expectations, the highlight last week was UK jobs data on the Wednesday, dealing a surprise to many. Although average earnings rose less than forecast, the unemployment rate dropped sharply from a pre-revised 7.2% to a staggering 6.9%. The GBP firmed off this news quite swiftly against all major counterparts, realising its strongest levels in 4 years.

Outlook: The UK economy appears to be outperforming expectations quite consistently of late and there is nothing to suggest that this progression is a short-term phenomenon. Although the UK employment rate dropping below the Bank of England’s previous target of 7.0% doesn’t have any true impact considering the central bank’s change of mandate, the news is still extremely encouraging, all the more so if one retraces their steps a few months to last year, when the BOE were predicting this event happening in mid-2015. This might also suggest why Mark Carney decided to alter their forward guidance to a more robust and less transparent set of conditions, having their optimistic in-house forecasts constantly outpaced. Going forward, there is likely to be continual strength in the GBP, but unlike the EUR, this price action will be supported and warranted from real fundamentals. Any positive economic data will support the idea that spare capacity is indeed being absorbed, effectively reigning in the timeframe for a rate hike.