Interest rate outlook driving dollar

Rate divergence likely to continue

Following Friday’s U.S. jobs report the gap between interest rates in the U.S. and eurozone is likely to widen further in the coming week, since the data all but confirmed a hike at the meeting of the rate setting FOMC next week.

The U.S. economy added 223k new jobs in May although the April data was revised down from 164k to 159k. The fact that the data was released on the first day of the month adds little to its credibility and there may well be a revision when the June data is released but traders were willing to take the data at face value.

The more reliable wage growth figures showed that salaries grew at a rate of 2.7% in May, up from 2.6%. This is an indicator of inflation “down the road” and is a measure used by the Fed. when considering short term interest rates.

Traders now attach an 80% probability to a rate hike which should provide the dollar with support going forward. Interest rates in the UK and Eurozone are on hold as economic conditions predict a slowdown for both.

The dollar index rallied following two “down days” reaching 94.44 before settling back to close at 94.19.

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Euro facing several headwinds

Following issues that have been faced by the dollar then Sterling in Q2, the euro is now facing multiple factors that are combing to push it lower.

While the smaller economies continue to grow, the economic cycle is starting to falter and growth in the stronger countries like Germany, Belgium and the Netherlands is unable to provide support. France continues to struggle with and has become a singular bell weather for the entire region, never quite managing to fulfil potential despite the optimism surrounding the President’s plans.

While there has been a relief rally for the currency following the decision to allow Italian coalition partners to form a Government, that Government is still going to be heavily Eurosceptic and the prospect of further disruption to markets is high.

Italy and its people remain one of the staunchest defenders of the EU but the population has turned decidedly Eurosceptic following the financial crisis. Italy is one of the nations that survived with high interest rates and high inflation prior to invoking the disciplines surrounding euro membership.

As such, in times of economic slowdown they were able to “devalue the currency and export their way out of recession.” That avenue has been closed and it has led to Italian anger and the prospect of a banking crisis which has been used by populist parties to gain popularity leading to the current situation.

On Friday, the euro fell to a low of 1.1616 as the dollar rallied but has opened higher in Asia overnight reaching a high of 1.1697.

Stronger data provides support for pound

While the overall direction for the pound appears to be lower as the markets await the UK Government’s Brexit proposals, it has staged something of a short-term rally towards the end of last week which has continued into the opening of markets in Asia.

Data released on Friday showed that manufacturing activity in the UK improved in May although the overall picture for the UK economy is still weak and falling.

The pound reached a high of 1.3363 on Friday before falling a little to close at 1.3348. This rise was more impressive since it came in the face of a rising dollar. Overnight tat rally has continued reaching 1.3378.

Weaker short-term short positions will have been “flushed-out” and it is unlikely that traders will be willing to “go-long” of the pound given the prospect of disappointment when the Government finally provides Brussels with proposals for the future relationship between the UK and EU following Brexit.

There have been rumours circulating over the thorniest issue, that of the border between the North and South of Ireland, a problem that has defined the entire Brexit process. Just how that issue can be solved will be the most important proposal, since it appears that no matter what is proposed one part of the Island will be disappointed, or worse.