ECONOMETER

US service sector confidence improved, with the ISM non manufacturing index revealing a stronger than forecast rise to 53.7 while the Fed’s Beige Book recorded “modest to moderate” growth across most Fed districts. However, any positive reaction was fully negated by a drop in the employment component of the ISM report and a weaker than expected ADP private sectro jobs report which revealed only a 135k increase in jobs. Consequently there will be a scramble to revise down forecasts for May US non farm payrolls released tomorrow.

Risk assets and in particular equities didn’t like what they saw even though on balance the data suggests less risk of the Fed beginning to taper its asset purchases this year. Added to the uncertainty revolving the around the Fed was disappointment on Japanese policy in the wake of Prime Minister Abe’s policy speech yesterday which failed to reveal details about his growth strategy or third arrow to reform business and deregulate parts of the economy. Central banks will remain in focus today although both are likely to be less volatile, with both the European Central Bank and Bank of England set to deliver unchanged policy outcomes.

USD/JPY’s pull back has continued unabated as disappointment over Japanese prime minister Abe’s ‘third arrow’ speech of structural reforms and a pull back in US Treasury yields taken together with firming risk aversion have all contributed to a firmer JPY. Clearly pressure will grow to limit the JPY’s bounce back but as long as Japanese equities continue to slide it will be difficult to do so.

Given that this is coinciding or perhaps spurring more Japanese selling of foreign assets as revealed in recent data, it is difficult to prevent a further drop in USD/JPY unless and until such flows reverse. Having dropped below its 50 day moving average level around 99.28 USD/JPY is vulnerable to more short term slippage.

EUR/USD is likely to struggle to make further headway and there will be plenty of caution around the ECB meeting today. While there is very little chance of a further easing in policy President Draghi is likely to keep the door open for further action which ought to take the wind out of the EUR’s sails.

While the EUR may be taking advantage of a softer USD tone as well as a narrowing in the US Treasury yield advantage over bunds (2 year) I don’t believe this will continue. It is only a matter of time before US yields renew their widening trend, with Friday’s US jobs data a possible trigger.

GBP is another currency taking advantage of a generally softer USD tone having made a solid recovery from its lows around 1.5008 at the end of last month. EUR/GBP has been more stable but we expect GBP outperformance here too.

While the BoE will offer little help given the likelihood of an unchanged policy decision firmer UK data in the form of better than expected manufacturing, construction and services purchasing managers’ indices revealed this week has provided a solid backstop for the currency. Given that positioning in GBP has been around record low levels it would appear that the potential for short covering remains significant.