CMC Markets

A dovish Draghi as well as some more disappointing US data helped underpin both European and US markets yesterday, with the S&P500 posting a new record high while markets in Europe also enjoyed a positive session, even as bond yields stabilised near recent highs.

Despite yesterday’s rebound stock markets still look set to close the week lower, a far cry from the euphoria we saw at the end of last week, in the wake of the Conservative election victory in the UK, though today’s price action might reverse that with a mixed open expected after last night’s strong finish in the US, and Draghi’s pledge to implement the ECB’s QE program in full.

Up until fairly recently all the talk had been of when the US Federal Reserve would look to start raising rates, against a backdrop of an improving economy, but recent economic data has slowly eaten away at that expectation with the result that now the talk is more about if they can raise rates.

Yesterday’s US economic data gave no new clues as to the timing of that decision, after core PPI prices for March showed an unexpectedly sharp decline. Coming as it did on the back of another weak retail sales number on Wednesday, the data has once again prompted further downward revisions to US GDP forecasts, and helped propel the S&P500 to a new record close last night, while US treasuries also recovered some of their recently lost ground.

While underwhelming economic data has assuaged concerns about an imminent rate hike and helped underpin stocks, it has had a less positive effect on the greenback, which until recently had been king of the currency castle, having hit a 11 year high last month against a basket of currencies.

This recent turnaround in the fortunes of the US Dollar Index has managed to put a floor under the euro which, until recently had all the look of a condemned man facing the gallows as it approached parity.

The recovery in the euro and improvement in European economic data appears to have brought the recent rally in the German bund market and the DAX to an abrupt halt as bond traders quickly reassessed the likelihood of an extended period of deflation in the euro area. The sharp sell-off in both has seen German 10 year yields rebound from lows of 0.05% to 0.7% in the space of a month, and the DAX drop from record highs of 12,390.

While ECB President Mario Draghi reiterated his determination to follow through on the ECB’s QE program to completion yesterday at the IMF, the last few weeks have raised the possibility that the recent rise in European bond markets in anticipation of the start of QE had been somewhat overdone and the pullback in recent weeks appears to reflect that.

Even allowing for that, the slowdown in the US does appear to have altered the chemistry of the recent US dollar rally, and this change could push the US dollar even lower in the coming months, and in the process potentially limit further gains in both the DAX and the European bond market, if the euro contains to push higher.

Investors continue to be remarkably complacent about the direction of the US dollar, with most still anticipating a move higher in anticipation of a move on rates in September, with more economic data due today.

The latest Empire manufacturing index for May is expected to show a rise to 4.75, from April’s -1.2 reading, while industrial production for April is expected to show an improvement to 0% from March’s 0.6% decline.

Even allowing for a decent set of data today the prognosis for a September rate rise seems slim. Investors appear to have forgotten that the Fed cut its growth and inflation forecasts at the March meeting, after dropping “patience” from the guidance language.

Given that the next meeting is next month and in light of recent data it is unlikely that the Fed would upgrade those forecasts at its June meeting, given that we only have one more payrolls number between now and then.

If we get a “wait and see” approach in June, which seems likely at the moment, then the earliest the Fed can act in revising its forecasts upwards would be September, and it would be unusual to do that ,and act on rates at the same meeting, which means the earliest we could get a move on rates now is either October, or December.

EURUSD – yesterday saw a move through 1.1400, bringing us closer to the 1.1500 area. The current rally is starting to look a little stretched but the euro continues to find itself well supported on any dips. Only a fall below the 1.1050 level negates the current upward momentum for a move towards 1.2000.

GBPUSD – having pushed above 1.5570, 38.2% retracement of the down move from 1.7190 to 1.4565 and the 200 day MA at 1.5630, suggests we could see a move towards 1.5880, the 50% level. Any pullbacks should now find support at 1.5570 as well as 1.5450.

EURGBP – after finding support at 0.7115 the euro looks set to push back higher again, towards the highs last week, but we need to break above the 0.7250 area and 50 day MA first. If we break back through here then there is potential to retest the 0.7300 area.

USDJPY – still range bound and stuck below the 120.70 level, we also have resistance at 119.70. Support remains near the recent range lows between 118.30 and 118.65.

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