Calmer sentiment

Gains in US stocks overnight will help to calm sentiment. The fact that US equities were able to shake off the 6%+ plunge in the Nikkei yesterday reveals the different perspectives in both markets. US markets were helped by a bigger than expected increase in headline US retail sales in May and a bigger than expected decline in weekly jobless claims.

A WSJ story that Fed Chairman Bernanke would highlight at next week’s Fed FOMC meeting that a “considerable” amount of time would pass before ending QE and raising rates also likely contributed to firmer sentiment while pressurizing Treasury yields lower. Commodities’ markets also showed some sign of stabilization.

The data slate today consists of mostly US releases including May industrial production and June Michigan confidence both of which are likely to record positive outcomes. Markets are likely to digest the data well and after recent bouts of volatility a period of calm ahead of next week’s FOMC meeting will be welcome.

The USD index has suffered a dramatic reversal of fortunes since reaching a high just under 84.5 on 23 May dropping by around 4.3%. Its tumble has taken place despite higher US bond yields and risk aversion, both of which would usually be expected to boost the currency. Fed tapering nervousness has done nothing to support the USD despite prospects of reduced asset purchases.

The USD’s move should not be seen in isolation, however. In the wake of major position adjustments across many asset classes usually strong correlations have broken down. Given recent record long USD positioning over recent weeks the pull back in the USD versus major currencies may have further to run but we suspect that much of the decline has already taken place. Given that the USD appears to be more strongly correlated to equities at present it may find some support from the gain in US stocks overnight.

Assuming that the USD’s declines begin to slow and even reverse the EUR is unlikely to extend its gains much further. The overall backdrop for the EUR is not particularly positive, with growth data remaining weak, albeit less so than in previous months. Additionally there are renewed concerns about Greece due to protests over the shutdown of the state broadcaster highlighting the difficulty in implementing crucial deficit cutting measures.

Meanwhile, European Central Bank Board member Mersch once again highlighted the possibility of utilizing negative deposit rates, which ought to prove to be a negative influence on the EUR, while other members including President Draghi continue to defend the potential use of OMT. EUR/USD will run into strong resistance around 1.3434 and I expect the upside momentum to fade over coming sessions.

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