USD and EUR contrasts

Finally markets appear to be reacting rationally to economic data. There was always a risk that strong US data releases would prompt renewed Fed tapering fears and result in a sell off in risk assets as has been the case in the past. However, the reaction to Friday’s much stronger than expected US October jobs data (+204k + upward revisions to previous months) was what would be normally be expected. US equities rallied, US yields rose and the USD strengthened.

While the US data added further weight to the potential for Fed tapering in December or January it was also recognised as evidence of a growing economy, and one that barely flinched in the wake of the government shutdown. This week’s US data is unlikely to detract from this view, with the November Empire manufacturing survey and October manufacturing production likely to have shown further improvements. This should ensure that the USD remains firmly supported over coming days.

In Europe, the opposite is true. Faced with very low inflation (this is an issue across most major economies) the European Central Bank cut policy rates last week and looks set to intensify its dovish shift with other policy measures to reinforce its forward guidance. Consequently the EUR sold off sharply and is set remain under pressure.

This week’s Eurozone data releases will add more weight to the argument for further policy actions, with Eurozone GDP set to barely expand in Q3 while inflation likely to be confirmed at 0.7% YoY in October. Meanwhile industrial production is set to have declined in September (-0.4%). Given the contrasts in data releases and in policy stance, EUR/USD is set to decline further, with initial support seen around 1.3295.

In the UK, there will be attention on the Bank of England’s Quarterly Inflation Report, with jobs data and retail sales also on tap. Faced with mounting evidence of firming growth, the BoE will likely have to revise its assumptions upwards. Consequently this bodes well for GBP and while gains against the USD are likely to be limited, EUR/GBP is set for a further downward correction, with a break 0.8300 on the cards shortly.

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