* EUR recovery withstands soft euro zone GDP release
We retain our that the path of least resistance continues to be the EUR/G4 crosses (EURUSD, EURUSD and EURJPY) being much more vulnerable to upside surprises on a 4-6 week view, as opposed to downward surprises. EUR has continued to hold up well despite a barrage of negative political headlines and softer economic data. On the political side, German press reports suggesting the German constitutional court ruling (Sep 12) on ESM could be further delayed had a neutral impact yesterday. But a reiteration from the Constitutional court that the ruling will still take place on Sep 12 has supported EUR further. Meanwhile, data-wise the still soft -0.2% q/q euro zone GDP reading (despite expectations for a stronger outcome on stronger individual country data) has not managed to hurt EUR via the ECB easing expectations route. The rise in EURGBP despite stronger UK CPI (2.6% vs. 2.3% expected) confirms our view that broader EUR sentiment will remain key for this cross. We continue to hold a long EURUSD recommendation targeting 1.2800 last week. The focus today will be on the US retail sales data, and a stronger reading could remain supportive for risk appetite and JPY crosses.
* JPY vulnerable to stronger US data
US July retail Sales should post marginal gains (0.2%m/m) for the first time in three months. Core retail sales are also expected to rebound after steadily decelerating from very strong readings earlier in the year. This could support USDJPY and JPY crosses should it lead to any further rises in US yields (See Chart). We continue to strategically like JPY better than either USD or EUR, but point out that JPY could be in for some tactical weakening in the weeks ahead. Indeed, the consensus on JPY appears to be bullish on a 4-6 week view. Arguments are linked to typical seasonal strength (JPY on average has been stronger in August). A big factor behind this view is linked to a pick up in US treasury redemptions, and presumably repayments to Japanese investors; note here that the amount of UST redemptions rise sharply to USD 116.4bn this month from closer to USD 50bn for July. However, we also point out that net JPY long positioning is also close to reaching stretched levels as per the CFTC. A continued rally in risk appetite along with some building hopes for BoJ easing at their September 19 meeting (given political progress on fiscal reform) could provide the catalysts for an unwinding of JPY long positions.
* USD sensitive to policy maker rhetoric; Moderate hawk speaks this week
Bigger picture, we continue to believe that the USD would remain vulnerable should the market begin to ponder QE3 heading into the August 31 Jackson Hole convention. This week, we would keep an eye on comments from the typically more hawkish Kocherlakota (speaks both Thursday and Friday). We have already heard more dovish tones from other FOMC members with Rosengren advocating open-ended QE, and Williams recommending initiating QE tied to economic outcomes. But Kocherlakota could be important given that he has not updated his personal view since May or so, having spoken on non-policy related topics. But for background, this member has been of a slightly more hawkish mind in the past stating that monetary easing is a blunt tool for dealing with a structurally higher unemployment rate. Should he sound more dovish than his usual self, it could provide some further confidence to sell the USD. Our economists continue to look for QE3 being announced in September with a 65% probability.
BNP Paribas