The dollar had pushed to fresh five month highs of $1.4910 against the euro in overnight Asian trade before retreating back to $1.5050s, as oil prices rebounded to $115.95 per barrel on the escalating conflict in South Ossetia. The dollar pullback was broad, while sterling bounced off its 21-month lows against despite an unexpected 0.6% decline in U.K. PPI.
Although the dollar has dragged the euro below the psychologically important $1.50 figure for the first time since late February, the first technically important support level stands at $1.4910-20, which coincides with today’s low. We mentioned in Friday’s note that the $1.49 figure is equivalent to 2% below the 200-day moving average (dma). The last time the euro broke more than 2% below its 200-dma was in 2005, when the fundamentals had temporarily moved in favor of the U.S. currency.
In order for the dollar to garner further upside momentum, the following must happen (in order of importance):
1.U.S. fundamentals show convincing signs of a turnaround (peaking unemployment, bottoming housing and rebounding consumer demand/retail sales).
2.Deepening weakness in the Euro zone coupled with signs of peaking inflation.
3.Evident signs of stability on the U.S. banking front to the extent of reviving foreign interest in US banking stocks and Agency bonds. U.S. stocks rally must also be accompanied by higher volumes, which has not been the case as of late.
Be careful what you wish for
The main advantage of a rebounding dollar has long been associated with falling oil prices and a reduction in the inflationary escalation of rising commodities in and out of the United States. But is the emerging global economic weakness and increased signs of demand destruction that have been instrumental in lowering oil prices, alongside the supply increases from Saudi Arabia. Therefore, the combination of deepening weakness in Europe and Asia coupled with an appreciating U.S. currency may jeopardize any hopes of a decent U.S. recovery, especially if protracted dollar strength erodes the vital contribution from net U.S. exports (exports minus imports) on U.S. GDP growth. The chart below shows that next exports have been the largest contribution to U.S. growth in the last five quarters, with investment in the red and consumption weakening. As personal consumption expenditure (PCE) weakens further following the fading of the stimulus package, the positive effect from the trade gap takes on a more significant role. A 6% to 8% appreciation in the dollar from these levels will increase chances of a double hump formation in U.S. GDP growth.
EUR/USD remains above key support
EUR/USD proves it could hold above the $1.4910-20 territory, but a renewed attempt to break the $1.49 figure cannot be ruled out with fresh evidence of a slowing Euro zone. Thursday’s release of German Q2 GDP is expected to show a slowdown to 1.7% from 2.6%, while Euro zone CPI is expected to be confirmed at a 4.1% annual increase in July. Key support stands at $1.4700, which is the trend line support extending from the $1.43 low and onto the 1.4360 low. Upside capped at $1.5150, followed by $1.52
USD/JPY drops below 110
The dollar’s retreat from its 110.40 high to 109.70 has been accompanied by the oil-driven dollar pullback, but emerging weakness from Japan may support the pair at 109. Only a renewed bout of reduced risk appetite is expected to accelerate the yen’s appreciation, particularly against the USD, GBP, CAD and NZD. As far as equities are concerned, we stick with our forecast for a top in 1,320 and 11,900 in S&P500 and the Dow respectively.
Sterling relief temporary
Sterling’s rebound against the dollar shows more lasting than the recovery on EUR/GBP. The unexpected 0.6% decline in UK PPI may signal the peak of factory inflation, which could have a dampening on consumer inflation in the medium term. Since inflation has been the only obstacle to rate cuts from the Bank of England, any prolonged evidence of peaking CPI is considered as an overwhelming negative for GBP. Cable’s latest tumble to 21-month lows is expected to resume later this month. $1.9020 stands as the 200-week moving average, which is expected to be called up before month end. Long term objective stands at $1.78.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
