US Dollar Ugly But Not Hideous

The USD has strengthened by around 5% since the beginning of the month. The move has been particularly sharp this week as higher risk aversion and intensifying fears about the eurozone periphery have given the currency a boost, albeit with the USD remaining one of the least ugly currencies amongst a fairly hideous bunch.

Eurozone country and overall ‘flash’ May purchasing managers indices (PMI) managed to further sour an already fragile mood yesterday, with the data revealing bigger than expected declines, albeit still at levels that are high in absolute terms. Data today is unlikely to result in any improvement in sentiment for eurozone assets, with the Germany IFO Business Climate index likely to slip, albeit from a relatively high level.

The EUR doesn’t need much of an excuse to sell off at present, with a softer IFO likely to provide further reason for investors to offload long positions in the currency. Against this background EUR/USD is likely to sustain a drop below the 1.4000 level, with the 100 day moving average level of 1.3972 likely to be breached shortly.

More importantly in terms of sentiment drivers the malaise in the eurozone periphery especially Greece remains the biggest risk for the EUR. As much as officials in Europe and Greece deny speculation of debt restructuring the market is far from convinced as reflected in the widening in peripheral debt spreads.

Greece’s Prime Minister Papandreou’s attempt to push through austerity measures in the Greek parliament yesterday by announcing accelerated asset sale plan and EUR 6 billion in budget cuts have done little to turn market sentiment despite the fact that at the least it shows a willingness to stick to the plan in the face of growing domestic resistance.

The USD has also edged higher against the JPY over recent days despite a rise in risk aversion. As revealed in the latest IMM data markets have been net long JPY over the past couple of weeks, with positioning well above the 3-month average, suggesting some scope for a liquidation of long positions. Nonetheless, the rise in USD/JPY has occurred despite 2-year US / Japan yield differentials remaining at a relatively low level suggesting that the USD may lose momentum, with USD/JPY resistance around 82.74 likely to cap gains.

GBP has also slid suffering in the wake of a resurgent USD and unconfirmed reports that Moody’s ratings agency is expected to announce that is placing 14 out of 18 UK banks on review for a downgrade. GBP is likely to trade nervously ahead of UK data releases today including public finances and CBI data, with further downside risks opening up. A drop below GBP/USD 1.6000 could see the currency pair test support around 1.5972.

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