* EUR recovery hostage to politics and data
EUR has continued to hold up well despite a barrage of negative headlines from politicians in the euro area. The price action plays to our view that EUR/G4 crosses (EURUSD, EURUSD and EURJPY) are more vulnerable to upside surprises on a 4-6 week view. Accordingly, we entered a long EURUSD recommendation targeting 1.2800 last week. But this week the positive EUR view could be tested by two factors this week: (a) politicians showing their opposition to requesting EFSF assistance and (b) weaker EMU GDP data (due Tuesday) which could raise expectations of an ECB rate cut in September. On (a), Italian economy minister Grilli stated that Italy does not need to tap rescue funds as ECB action could be enough to ease tensions in the sovereign bond markets. The ECB will dislike such commentary as they have cited government request for assistance as a pre-condition for further action; ECB Coene has already come out suggesting it is all down to the politicians to act first. Should the market test the politicians and if peripheral yields rise, this could hurt any EUR recovery. On (b), tomorrow’s eurozone Q2 GDP reading will be important. Our economists look for a -0.3% q/q print; a weaker reading could see ECB easing expectations for September pick up. Hence, this week should provide some more clarity on whether it is falling euro area stress (EUR +ve) or increasing ECB rate cut expectations (EUR –ve) which will be the dominating factor.
* FOMC rhetoric on QE3 important for sustaining USD weakness
We continue to retain our short USD bias against the commodity currencies. Two big factors, namely (a) market pricing of lower euro area tail risks on expectation of ECB action and (b) building Fed QE3 expectations should see USD weaken. The market should begin to ponder the potential effects of an “open-ended” QE which is beginning to gain favour amongst a section of the FOMC. This could see the USD continue to remain under pressure. Stronger US retail sales this week may not disturb this view, but USD could become more sensitive to how other FOMC members feel about such a policy. We would keep an eye on comments from FOMC neutral member Kocherlakota (who speaks twice this week). Our economists continue to see a 65% chance of Fed easing at the September FOMC meeting. Thus, we remain bearish on the USD.
* BoE Minutes and labour market data to provide further insight to BoE policy
Following the BoE’s Inflation Report that reduced expectations of a rate cut, the BoE minutes this week will be gleaned for clues on the BoE’s policy direction. We expect the MPC to cut the policy rate and announce additional QE of GBP 50bn in November. Labour market data released this week will also be of importance in gauging expectations on the growth outlook, which has proved to be subpar thus far. On EURGBP, broader euro-area stress should dominate as a driver of BoE policy expectations. We continue to remain wary of upside risks to EURGBP in the weeks ahead, given the expectations of ECB action to sovereign debt yields. However, we look for better levels on EURGBP to express our long-term bearish view that is based on the UK’s growth out performance vs the euro zone as monetary stimulus in the UK should support the recovery.
* IMM Positioning shows speculative community turning more positive on commodity FX
IMM Positioning for the week ending August 10 shows that the speculative community slightly reduced their net short positions. It looks like the IMM community is becoming even more positive on the commodity currencies including AUD, CAD, and NZD as they continue to accumulate long positions. Positioning is no where near extremes and would suggest that commodity currencies could have further to run as prospects of QE from the Fed and ECB response to lower risk premia rise.
BNP Paribas