Following an onslaught of disappointing economic news globally the outcome of the US May ISM non-manufacturing index came as a relief, with the index rising to 53.7 from 53.5. Taken together with reports of a credit line to Spain from Europe’s bailout fund, it left markets in perkier mood overnight.
As per usual form, the emergency G7 conference call on the Eurozone turned out to be a non event while Fed speakers including Bullard and Fisher downplayed May’s soft jobs report. Much in terms of market direction today will hinge on the outcome of the European Central Bank (ECB) meeting and press conference, with positive sentiment likely to trickle through into trading until then.
The ECB will be under considerable pressure to cut interest rates today and a 25bps rate cut could be delivered. While the outcome is by no means clear cut and not pre-warned by the ECB a rate cut would at least help to alleviate a little of the pain in Europe. The fact that EUR/USD has a reasonably strong correlation with interest rate differentials over the past 3-months suggests that the EUR will actually come under pressure in the wake of such a move.
Even the reaction is not obvious, however. Arguably a rate cut could also be good news for the EUR as it would help to underpin growth. Moreover, a policy rate cut is largely priced in so the impact on the EUR will not be as potent as it could have been had it not been discounted. The accompanying statement will also be of interest. If the ECB indicates that it will cut rates further it will put even further more pressure on the EUR. Near term downside EUR/USD support is seen around 1.2375.
USD/JPY shows little sign of breaking its downtrend. A combination of further yield compression (2 year US bond yield advantage over Japanese yields continues to narrow) and elevated risk aversion has led to a firmer JPY much to the frustration of Japanese officials. Against this background it was perhaps unsurprising that Japanese finance minister Azumi pushed for the G7 to reaffirm its policy stance that excess volatility and disorderly FX movements are undesired. He faced no opposition in his request, paving the way for Japanese FX intervention to weaken the JPY.
The problem for Japan is that the impact of any intervention will be short lived against the factors mentioned above. Nonetheless, intervention fears will at least engineer a degree of two way risk into markets. Technical support for USD/JPY will be seen around 77.95.