Euro Corrects as U.S. Expands

Technical correction dressed as ECB concern

The Euro yesterday corrected from its recent highs against the dollar and pound in a classic reaction to having reached its medium-term target. The breach of the 1.2000 level against the dollar and the failure to break strong resistance at 0.9330 versus brought about the selling.

To explain the fall, analysts looked towards the ECB and manufactured a concern over recent Euro strength. Mario Draghi, the ECB Chairman rarely enters conversation over the strength or otherwise of the currency, viewing its level as a by-product of economic activity and monetary policy. The advent of the common currency joining the Yen and Swiss Franc in attaining safe haven status is a consequence of the region’s’ current account surplus and adds to the currency’s strength.

An ECB colleague of Sr. Draghi, Estonian Central Bank Chairman Ardo Hansson recently commented that the strength of the single currency was unsurprising considering the upbeat Eurozone economy. It is unlikely that this impression is contrary to the view of Draghi or that it isn’t the common view of his colleagues on the ECB Council.

The Euro fell 0.7% against the dollar and has reached 0.9186 against Sterling.

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Sterling takes a breath

The pound remains firmly below the 1.3000 against a dollar but managed to hold its own yesterday as upbeat economic data drove the greenback higher.

The confused state of the British negotiating position over Brexit is now well priced into the pound and it is the economy that is driving the currency. Further weak data for August will see the pound resume its path lower and the MPC meeting in two weeks won’t be able to provide support. In fact, given the parlous state of the economy there may be calls for a further loosening of monetary policy.

Inflation was, until recently, the major concern for the Bank of England. The reality of Brexit is understood by business but the lack of clarity over the path from today’s position to exit from the EU is driving business sentiment and investment lower.

Sterling remains hugely undervalued on a trade-weighted basis but as confidence ebbs away and the gap between wages and prices remains, further falls remain the most likely outcome.

Parliament returns from its summer break next week and with the Conservative Party Conference looming we can add politics to the mix and that is unlikely to be supportive for the currency.

U.S. GDP springs a surprise

The preliminary releases of U.S. growth data for the second quarter had shown an economy that was growing at 2.6%. Yesterday’s release of the “final cut” of GDP data was expected to show some improvement given the new-found strength of the jobs market and the improved trade position due to the weaker dollar. However, the 3.00% number took traders by surprise and was the catalyst for dollar buying particularly against the single currency.

Added to this was an upbeat report on private sector jobs which is a precursor of tomorrow’s nonfarm payrolls report. Market expectation has been heightened by the most recent releases both of which have reported 200k+ new jobs. Yesterday’s ADP report will have done nothing to dampen expectation over tomorrow’s data.

Further strong data releases will bring greater support for the dollar and fuel expectation for another rate hike. It had been usual that the Fed never hiked rates in December or in the wake of an election but given both traditions were broken last year, speculation over a further hike in December this year will return as activity improves.

It is a testimony to the amount of liquidity in the market that the reaction to the strong data was fairly muted and it remains to be seen how far the correction against the single currency can go.