GBP/EUR 1.2163 (0.8223)
The USD rallied through yesterday alongside the benchmark US equity indices, another hint that the USD is somewhat removed from its risk on/off positioning. In our view this leaves the USD well placed, likely to benefit from the continued improvement in the US economy and the Fed’s taper progress, and also well positioned should we see an increased bout of fear and risk aversion, where the greenback should find some lift from the rush into secure US treasuries.
Emerging markets are the hot topic at the moment and we continue to see EM central banks scramble to try and address the much hyped weakness. Again this has benefited the USD but there are other factors helping the dollar. Obviously the commitment for the Fed to continue the pace of QE reduction helps, the removal of the economic safety net is a sign of confidence in the economic recovery and the first reading of the Q4 GDP estimate saw growth at 3.2% annualised. When we put this together with the Q3 reading of 4.1% we have the strongest half year growth in over a decade.
Another reason behind our forecast in further USD strength is the pickup in interest rate expectations that will grow as tapering concludes. We have seen the market already begin to price in rate hikes within the next year (30bps), while this may be a little optimistic but the faster the Fed wind down QE, the quicker we will see interest rate expectations rise.
The EUR was facing selling pressure yesterday despite further evidence the region is showing signs of improvement. Jobs growth in Germany outpaced estimates by four times, with unemployment at 6.8% matching multi decade lows. Spain showed Q4 growth of .3% but still the single currency dropped. This is the first time in a while we have seen the Euro show this kind of vulnerability, usually impervious to negative data and rallying on the smallest glimmer of growth, the tide could be shifting as expectations grow for further ECB action.
This brings us to January’s CPI reading due this morning, which headlines the European calendar. The headline inflation rate is expected to rise to .9% following last month’s shock fall to .8%. Inflation continues to remain well below the ECB’s target of 2% and with deflation already a real factor in many of the Eurozone economies unless we see steady improvement in this figure the EUR is likely to face additional selling pressure.
Later in the US session we have the University of Michigan confidence report and the Chicago PMI figure for January. Adverse weather conditions in the US may well have an effect on December/January data and the Chicago PMI figure is expected to fall to 59 from 60.8 in December, although the Michigan confidence report is due to show continued improvement.