Sterling has extended yesterday's gains scored in response to the slightly higher than expected August CPI. It is trading at its best levels since last September. Chancellor Hammond's suggest that the UK will seek a transition period that is essentially an extension of the status quo fans hopes of a softer Brexit and this is also seen as supportive for sterling.
The August employment data is awaited. The main issue here is not job growth per se. As has been the case in the US and Japan too, job creation in the UK appears fairly healthy. The problem is the limited wage growth. This is arguably a more acute issue in the UK because of the rise in inflation, which saps the purchasing power of households. The Bank of England's Monetary Policy Committee meets tomorrow. At full force, now that a new Deputy has been named, a 7-2 vote is expected in favor of standing pat.
We have been identifying the $1.3430 area is a reasonable technical target for sterling. It represents the 50% retracement of sterling's losses since the day of the referendum June 2016 when it briefly traded $1.50. Also helping sterling is the unwinding of short cross positions against the euro. The prospects that the ECB tappering, which some participants had seen as urgent due to the self-imposed rule on the asset purchases, now appears to be a more prolonged process that could persist well into 2018, may have encouraged some profit-taking.
The euro poked through GBP0.9300 in late August amid calls from many investment houses for a move to parity. At the peak, it had moved beyond its upper Bollinger Band (two standard deviations above the 20-day moving average). In the first part of September, the euro has pulled back 3.5% against sterling and is now moving below its lower Bollinger Band. The low for the cross this year was reached before the French elections in April near GBP0.8315. The GBP0.8930 area represents a 38.2% retracement of the four-month rally. In addition to the violation of the lower Bollinger Band, the slow Stochastics are showing preliminary signs of a bullish divergence for the euro.
US 10-year Treasuries fell for the second session yesterday, lifting the yield to a two-week high near 2.17%. Before last weekend, the yield brief traded near 2.03%. Similarly, the 10-year German bund yield jumped from about 29 bp before the weekend, a two-month low, to over 40 bp yesterday, a three-week high. It stalled there and is slipping a little today.
The rise of yields had helped lift the dollar from JPY107.30 that had been approached before last weekend above JPY110. However, with yields stalling, the dollar is trading in narrow ranges as the momentum eases. The high from late August was seen near JPY110.65 and this offers a nearby cap. We peg initial support near JPY109.40.
The euro recovered from its push toward $1.1925 yesterday to trade to nearly $1.20 in Asia. Although it has stalled there in early European turnover, the market does not appear to have given up. We suspect that it can push toward $1.2020 before some of yesterday's bottom pickers take some quick profits. The next key technical objective we have noted is found near $1.2165, the 50% retracement of the euro's slide from the mid-2014 high.
Technically, this suggests the euro's stronger than anticipated recovery this year is still well within the parameters one would expect in a correction, rather than a new trend. Having talked with many people attending the TradeTech Europe FX conference in Barcelona, we remain struck with extreme negativity to the dollar, with some participants suggesting potential toward $1.30-$1.50. The pessimism toward the US is palpable. The possibility that Yellen gets reappointed, that the Fed raises rates again over the next 15 months, or that tax reform is delivered are seen as extremely low. We suspect the source of volatility will come from one or more of these events taking place.