Daily Market Brief 11 May 2017

Fundamentals Drive Dollar Higher

May 11th: Highlights

  • June hike 90% certain
  • Draghi remains cautious
  • MPC Meeting and inflation report today

Interest Rate Differentials push dollar to eight week high

Fears that the sacking of FBI Director James Comey would lead to an impasse between Donald Trump and Congress have been largely ignored. Interest rate futures are pricing in a 90% certainty of a hike in rates ate the FOMC meeting due to take place on June 13-14.

The fallout from yet another piece of precipitous behaviour from Trump has not gone away completely and his motives are still being questioned but, for now, that is taking place behind closed doors.

The dollar index rose to 99.70 driven primarily by a surge in the dollar against the JPY. Japanese monetary policy remains ultra-easy and will remain so as the country fights the threat of deflation. Interest rate differentials are a major driver of fundamental currency movement and the gap between the U.S. and Japan is set to continue to widen.

The Euro and Pound remain in relatively tight ranges. The bout of profit taking following Emmanuel Macron’s victory in the French Presidential Election has abated. The single currency is well supported at 1.0860 but a further test of 1.1000 depends on the ECB.

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Draghi remains cautious

There was an air of optimism surrounding a speech by Mario Draghi to the Dutch Parliament yesterday. The first speech since political worries that had been dogging the Euro had lifted was expected to signal a change in sentiment.

The reality was a little disappointing and it was a testament to both the resilience of the Euro and the amount of liquidity in the market that reaction was muted.

Sr. Draghi believes that it is too early to say that the spectre of deflation has been defeated. There is no doubt that the economy is improving but with pockets of concern, particularly over employment, interest rates will remain at the current level a little longer. The asset purchase programme designed to add liquidity will also stay “for now”.

The next monetary policy meeting of the ECB isn’t until June 8th but given the pace at which most EU related issues move, that is nowhere near enough time for a change of heart!

The ECB remains in a negative bias regarding the Eurozone economy and it is conceivable that a switch to neutral could be seen but in practical terms, a change in monetary policy is still some way off.

Sterling buoyant as MPC meets

The pound is poised for a further assault on the 1.3000 level against the dollar as the twin drivers of the economy; growth and political stability add support.

A sustained break higher against the dollar may be difficult to sustain given the clear interest rate bias of the FOMC. However, as Brexit talks begin in earnest a realization that the headwinds won’t be in a single direction, together with continued monetary policy caution, a break towards 0.8000 against the Euro cannot be ruled out.

Today’s release of the Bank of England’s Quarterly Inflation Report will attract most attention. This is the most forward looking piece of official information available to the market. The analysis and projections contained in this report are a major driver of monetary policy.

The recent strength of the pound, mostly attributed to political factors will have had an effect already on inflation and should be prominent in the central bank’s thoughts. A leading research institute lowered its peak inflation forecast this week from 3.7% to 3.4%. Still higher than official estimates but a move in the right direction.

Following the inflation report the MPC vote on interest rates is likely to be 8-1 or 9-0 dependent upon how the one dissenting voice, that of Kristin Forbes, views the outlook for inflation and the economy.

Have a great day!

About Alan Hill

Alan has been involved in the FX market for more than 25 years and brings a wealth of experience to his content. His knowledge has been gained while trading through some of the most volatile periods of recent history. His commentary relies on an understanding of past events and how they will affect future market performance.”