Two steps forward, one step back appears to describe the movement of the US dollar over recent weeks. Although the dollar is still off its lows registered at the beginning of June it has failed to make much of a recovery. After a solid start to the week the dollar came under renewed pressure ahead of the FOMC decision but managed to register small gains following the lack of action from the Fed on Wednesday. Overall, the Fed showed slightly less concern about disinflation and became slightly less negative on the economic outlook but there was not much in the Fed statement to impact the dollar strongly.
Some comments by ECB officials noting that European interest rates are unlikely to be cut further and that further expansion of stimulus measures are not needed, likely explained some of the recent bounce in the euro versus dollar, but the massive ECB allocation of EUR 442 billion in its 1-year tender on Wednesday helped to push the euro lower once again. The demand for funds from banks was extremely strong and the ECB responded by providing a huge amount of emergency credit. The allocation drove down overnight and long term rates as well as weakening the euro.
I still believe any gain in the euro will be limited especially as the Eurozone data flow continues to suggest that any recovery will be tepid. Eurozone June PMIs this week revealed a small rise in the manufacturing index but a surprise fall in the services index. There was also some improvement in the French INSEE business confidence indicator but at most the data pointed to a slower pace of contraction and continue to lag the improvement in similar surveys in the US and UK. EUR/USD appears to be trapped in a 1.38-1.43 range with little momentum to break either side of this.
FX markets are set to remain volatile but within ranges. The failure of the dollar to extend gains amidst thin data flow highlights the lack of direction in markets. I am still biased towards some dollar upside over coming days but once again currencies will take their cue from equity markets. The dollar may find some support if US equities continue to struggle; the S&P 500 is finding it difficult to sustain gains above its 200 day (897.2) and 50 day (900.54) moving averages, suggesting some scope for a downside move in US stocks an in turn a firmer dollar if the S&P 500 fails to hold above this level.
GBP/USD looks resilient despite coming under pressure following comments by BoE Chief economist Spencer Dale that a weak currency was a “key channel” to spur growth. Although GBP has recovered sharply from its low of 1.3549 touched on 26 January it is still looks undervalued and such comments do not necessarily justify a further drop in GBP. Although GBP/USD is set to appreciate further over the coming months it could struggle to sustain a break above its 3 June high of 1.6663 over the near term. The downgrade to UK growth forecasts by the OECD this week and comments by BoE governor King that UK recovery will be a “long, hard, slog” highlight the difficulties ahead.