FX Daily Strategist: Europe

The initial reaction to the rise in China’s money market rates has translated into lower US Treasury yields and weaker equity markets, with the USD continuing on the back foot. Overnight, China’s manufacturing PMI rose to a seven-month high of 50.9. In our view, the pullback in risk sentiment should remain temporary as the delay to the Fed’s QE tapering plans until Q1 of 2014 makes long carry positions attractive. This implies that commodity and EM currencies should regain some lost ground. At the same time, the USD remains vulnerable and we suspect there will be little appetite to rebuild long positions at this juncture. One potential source of support for the USD is the reciprocal dovishness of other central banks, which could offset the impact from the shift in the Fed expectations. The case in point is the dropping of the tightening bias by the Bank of Canada at the monetary policy announcement on Wednesday. We would also not discount the possibility of incoming US data starting to surprise to the upside, although in the context of potential data collection issues, during the government shutdown, it will likely take a while before a ‘clean’ US data trend emerges. Today we expect initial jobless claims to fall slightly to 350k, while the August trade deficit should narrow to USD38.5Bn. Our only long USD exposure is currently through short GBPUSD with a stop set at 1.6310.