An unexpected increase in Germany’s IFO business sentiment survey in May is accelerating the pace of the dollar decline, broadening the sell-off beyond just rising oil. The dollar hit a fresh three-and-a-half-week low against the euro at $1.5756, while testing the 103 yen level for the first time in a week. Oil prices hit a new record at $130 per barrel on fading market expectations of any output reductions by OPEC after the cartel said the world is all already well supplied.
While markets have focused on the dollar impact of a possibility of an improvement in U.S. economic conditions, they have largely ignored the euro impact on an improvement in the Euro zone. The assumption that the Euro zone economy will have to traverse further deterioration and lag behind a U.S. economic recovery has been broadly circulated, to the extent of ignoring the possibility that both economies may start to stabilize from their own respective downturns. Considering that the U.S. downturn has been deeper than its Euro zone counterpart, a recovery in the latter suggests more positive ground for the euro than the dollar, especially as it means a possible rate hike.
The 2 p.m. EST release of the April Federal Open Market Committee (FOMC) minutes may provide some stability to the beleaguered greenback in the event that they show the Committee to be considering a near-term pause in its easing campaign. Although the April FOMC statement showed almost no sign of a shift in the language, a broader discussion of the inflation risks in the minutes may help the greenback.
Euro soars on IFO, oil
The IFO’s business climate index rose to 1.03.5 in May from 102.4, beating expectations of a decline to 102. The 1.1 point increase was the highest monthly rise in the climate component since December 2006. The business conditions index rose to 110.1 from 108.4, while the expectations index rose to 97.3 from 96.7. The better than expected German figures offer a crucial fundamental boost for the euro rally that goes beyond surging oil, thus likely to call up the $1.58 figure in the current session. The release of the April FOMC minutes may provide some dollar stability as it lends fresh credence to the notion of a possible pause by the Fed in June. Support climbs to $1.5720, backed by 1.5680. Key upside target stands at 1.5830.
Sterling awaits retail sales, BoE
The minutes from this month’s Bank of England interest rate decision showed only arch dove MPC policymaker David Blanchflower to have voted for a 25-bp rate cut to 4.75%, with the remaining eight members preferring to stand pat due to rising inflation risks. Spike in consumer price inflation to 3%. The minutes stated: “A further reduction in Bank Rate this month could create the impression that the Committee was trying to stabilize output growth rather than maintaining its focus on the inflation target.” Indeed CPI surged to 3.0% annually last month, well above the 2.0% target. Res on banks' balance sheets,” the minutes said. But the minutes were also mindful of “…a significant risk that the impact of weakening property markets on the rest of the economy could be more substantial than implied by the central projection.”
Although markets are cognizant of the BoE’s assessment of seeing further short run up in inflation, they continue to price in at least 50 basis points in rate cuts for the year. We see an 80% chance for rates to be cut by 75 bps this year, with 25% chance for a full percentage point. We continue to be skeptical of the sterling rally, seeing key resistance at $1.9720, followed by the key 1.9750, which is the 100-day moving average as well as the 30% retracement of the $2.0390-$1.9360 decline. Downside seen heading towards $1.9620, backed by $1.9580.
USD/JPY eyes 102.70
Broad dollar losses and global investor nervousness are conspiring to accelerate the slide in USD/JPY. As the move nears our projected 103.00 target, we reiterate yesterday’s 102.70 forecast. Despite the ensuing losses in equities, then yen has remained mostly offered against non-USD currencies as soaring oil prices are a negative for the oil-dependent Japan. On a longer term horizon, we expect USD/JPY to approach 102.50 before settling at 101.80-102.20.
Aussie extends to 24-year high
The Aussie continues its broad rally, led by fresh 24-year high against the USD at 0.9652 as markets prolong the gains following Tuesday’s release of the hawkish RBA minutes. The broad rally in commodities underlined by a fresh four-week high in gold at $923.80 per ounce is speeding up the moves. We recall yesterday’s FX charts strategy arguing for 98¢ as the next key target, barring further sell-off in equities (more than 2.0%). Interim resistance stands at 0.9665-70. Support climbs to 0.9570, backed by 0.9530. On the longer term, key foundation is firmly cemented at 0.9270.
CAD hits two-month high
CAD surges to two-month high against the greenback after annual inflation rose 1.7% in April following 1.4%, beating expectations of 1.4%. Annual core CPI rose 1.5% from 1.3%. Although the figures remain well below the Bank of Canada’s 2.0% target, they served to accelerate the currency’s oil-driven gains of late. The report does not alter expectations of further BOC rate cuts but is not yet signaling any a turnaround in the CAD’s up move. An improvement in equity market conditions is seen dragging the pair towards 0.9815, backed by key support at 0.9770. Upside capped at 0.9870
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
