Dollar still supported by rising US bond yields

On Wednesday,  trading in the EUR/USD cross rate was remarkably calm for most
of the session, especially if one takes into account the rating action of Moody’s on
Spain. Just before the start of European trading, the rating agency put the credit rating of Spain on review for a possible downgrade. EUR/USD tested bids just below
the 1.33 mark after the announcement, but at first there were no follow-through
losses. EUR/USD settled in a sideways trading pattern in the 1.33 area during the
morning session in Europe. The pair even temporary reversed the earlier losses going into the US trading session. So, the damage from Moody’s rating action on the
euro was very muted. The US eco data confirmed the scenario of a gradual recovery. At first, the reaction of the currency markets to these data was limited. However,
later in the session the pressure on EUR/USD was getting bigger. We didn’t see a
specific news event that triggered the move. Looking at  the price action in other
cross rates, the move should in first place be seen as dollar strength, rather than
euro weakness. The move occurred in step with a another down-leg of US Treasuries/rise in US bond yields. At the same time, global equities ceded ground, too. This
combination of rising interest rate support for the dollar in an environment of investor
caution on risk obviously was not favourable for the single currency. So, EUR/USD
started a gradual decline that continued throughout the whole US trading session.
The pair closed the trading session near the intraday lows at 1.3214, compared to
1.3378 on Tuesday evening. The pair is still seen in this area this morning.


Today, currency traders will keep an eye on the advanced reading of the European
PMI’s. Last month, the PMI’s, especially of the core European economies, showed
quite a remarkable progress. It will be interesting to see whether this strong momentum can be maintained. Maybe the risk is for a small set-back of last months strong
performance. Such an outcome might be (slightly) negative for the euro. The EU CPI
data are interesting, but probably no big issue for the currency market. In the US, the
calendar contains also quite a long series of eco data releases. However, we don’t
expect them to change the broader picture for currency trading. The US housing data
are notoriously volatile. The Q3 current  account is interesting for economists, but
from a market point of view it is a bit old news. The claims and the Philadelphia Fed
have probably most market moving potential. Of late, positive US data, via their impact on US bond yields, were dollar supportive. Next to the data there will of course
be a lot of media coverage/analysis of the European crisis ahead of the EU summit
that is taking place this evening and tomorrow.


President Van Rompuy will propose a text, that will make it possible to integrate the
ESF (the safety mechanism for after 2013) into the EU institutional framework. From
a market point of view, this won’t be a major event. Next to this ‘juridical’ issue, there
will still be a lot of speculation on other issues as there are a possible increase of the
amount of the EFSF, the issuance of an E-bond and/or the need for raising the capital of the ECB. Over the previous weeks, the debate on these  issues most often weighed on the single currency. We still assume that investors will stay cautious to take (additional) euro exposure on board before the outcome of the summit will be known. That said, we have the impression that the euro has become a bit less sensitive to ‘negative’ headlines on the E(M)U crisis (cf yesterday’s reaction the rating action on Spain). So, the dollar side of the story might at least be as influential as the euro story. Nevertheless, the combination of the two still suggests further EUR/USD weakness short-term.  
Global context. Since early November,  EUR/USD is captured in a negative
trend. The trade-weighted dollar reached a new correction low (75.63) after the November Fed decision to embark for QE-2. EUR/USD reached a top in the 1.4280
area. However, the negative impact of QE-2 on the US dollar faded soon while the
tensions in peripheral Europe came again to the forefront. EUR/USD was ripe for a
more pronounced correction. Contagion fears kept  the euro under pressure.
EUR/USD reached a correction low at 1.2969 two weeks ago. Since early December, the tensions on the European markets eased as ECB bond buying gave investors some comfort. This caused a temporary short-squeeze in EUR/USD too, but the move had no strong legs. The rebound ran into resistance in the 1.3440 area. Regarding the USD side of the story, the signals were mixed of late. Bernanke kept
door open for more QE, while at the same time the budget agreement between the
Obama administration and the Republicans was seen as supportive for US economic
growth. Nevertheless, until Monday,  the US budget agreement and the subsequent
rise in US bond yields were seen as USD supportive. The euro made a temporary
comeback to the 1.3500 area early this week, but  failed to recapture the uptrend line
from the year lows (today in the 1.3500 area). In case, EUR/USD would regain this
line in a sustained way, the short-term picture would improve opening the way for a
retest of the 1.3698 level (previous  range bottom)/1.3786 (22 Nov high) area. We
held/hold on to the view that a break above this area won’t be easy. Such a
move would probably imply a material deterioration in the global market appraisal of the US dollar. We don’t exclude such a scenario further out in 2011.

However, with uncertainty on the euro still high and US eco data improving,
this is not our favorite scenario short-term. We hold to the working hypothesis
that the topside in EUR/USD might be difficult  and  we continue to put the risk
for a retracement lower in the 1.3500/1.2969 trading range.


On Wednesday,  USD/JPY extended its come-back off from Tuesday’s low in the
82.85-area. As was the case for most other dollar cross rates, the move was in the
first place due to global dollar strength. This was especially the case during the US
trading hours. Rising US bond yields even pushed the pair temporary beyond the key
84.41 resistance area. However, the test was rejected and the pair at 84.24, compared to 83.66 on Tuesday evening.

This morning, Asian equity markets show no clear trend. USD/JPY is drifting sideways near yesterday’s closing level.
After the Mid-September interventions, USD/JPY trading for some time became
a tactical game between the BOJ and the market. Investors felt comfortable with yen
long positions (USD/JPY shorts) as Japan was considered to have little room of maneuver to execute a strategy of aggressive interventions to stop the rise of the yen.

Indeed, the debate in the G20 was about excess countries taking steps to artificially
lower the value of their currency. However, finally the global  decline of the dollar
slowed and USD/JPY developed a  bottoming out process.  The rise in US bond
yields was an important driver behind this move. This improved the ST technical picture in the pair. We didn’t/don’t expect a major U-turn in the USD/JPY cross
rate. Nevertheless, there was room for repositioning in a unidirectional positioned
USD short/yen long market. Two weeks ago, the 84.40 area was tested several
times but no break occurred. From there, we reinstalled a cautious sell-on-upticks
strategy for return action to the 80 area. Early this week, it looked that the attack
on the 84.40/50 area was finally rejected. However, it was obviously too early to cry
victory. Yesterday, the pair even set a minor new high at 84.50. A break beyond this
level would open the way for a rest of the post-intervention high at 85.95 area. US
bond yields remain the key driver in this cross rate. We keep tight stop-loss protection in the 84.50 area to shield USD/JPY short positions against the potential fall-out
of such a further rise in US bond yields.


On Wednesday, EUR/GBP extended the rebound at started on Monday. The moves
were in the first place order driven. The UK labour market were close to expectations
and the CBI reported sales were much better than expected. However, EUR/GBP
even spiked higher after the CBI report. At that time, the move was supported by an
(albeit very moderate) rebound in EUR/USD. The pair breaking north of the 0.8500
level triggered additional stop-loss euro buying/sterling selling. The pair reached an
intraday high at 0.8548 late in European trading. From there, a moderate correction
(in step with brooder EUR/USD sales) kicked in. The pair closed the session at
0.8500, still slightly higher compared to the 0.8480 close on Tuesday evening. Looking at the price action of EUR/GBP, yesterday’s move should be considered as disappointing from a sterling point of view.
Today,  the calendar of eco data contains the UK retail sales. Considering recent
evidence of other indicators from this sector, the risk might be for the figure to come
out on the strong side of expectations. However, was  illustrated yesterday, even
such a scenario is no guarantee for a comeback of sterling.

Global context:  from late August till end October, EUR/GBP rebounded from the
0.8200 area to reach a recovery high of 0.8942 on October 25. Investors discounted
higher chances that the BoE would join  the Fed and enlarge its program of asset
purchases. The harsh UK budgetary measures were seen as a potential drag on UK
growth and this could be a good reason for the BoE to maintain an accommodative
approach. This kept sterling under pressure. However, stronger eco data (especially
strong Q3 GDP) torpedoed the hopes for additional BoE policy accommodation
short-term and helped sterling to regain ground. Rising tensions in the euro zone
were also a good excuse to scale back EUR/GBP exposure. The pair dropped below
the key 0.8532 support area and reached a correction low in the 0.8335 area two
weeks. From there, the pair joined the broader rebound of the euro.
Longer-term, we don’t expect a major comeback of sterling. The debate on more
QE is delayed, but probably not closed. The impact of  the budgetary measures on
growth has still to materialize and we assume that the BoE will lag the ECB on the
way to policy normalization. Two week’s ago, the pair showed some tentative signs
of bottoming. So,  we installed a cautious buy-on-dips approach. Last week,
global sentiment on the single currency remained fragile. In addition, the UK currency didn’t trade that bad either. So, the day-to-day momentum didn’t go our way.

Nevertheless, we maintained our tactics. We don’t cry victory, but the price action
over the previous days gave us some breathing space. The pair regaining the
85.27/98 area (recent highs) would further  improve the short-term picture for
this cross rate. On the downside the 0.8335 level (Dec 01 correction low) remains
the line in the sand.
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Full report: Dollar still supported by rising US bond yields