Do Not Buy the EUR/USD Rally

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The euro rebounded against the U.S. dollar today but we believe this represents nothing more than a dead cat bounce for the EUR/USD. The greenback traded lower against all of the major currencies, which means that the recovery can almost entirely to attributed to dollar weakness. The euro received a little bit of support today from reports that the European Central Bank will refrain from announcing new measures next week but we never thought this was likely considering that some of the measures introduced in June have not been rolled out yet. The only reason why there was any speculation at all about stimulus next week was because Draghi expressed concerns that inflation expectations are falling. Based on the recent drop in German producer prices and the expected decline in German CPI tomorrow, inflation is indeed moving in the wrong direction but we are not sure whether this is enough to push the central bank to introduce new stimulus prematurely especially since the recent sell-off in the euro will help boost price pressures. With this in mind, we do expect Draghi to signal that another program is coming which would be a slightly stronger message than past months when he simply said they are ready to act if needed. For this reason, we believe that the EUR/USD rally today represents nothing more than a dead cat bounce and that the currency pair is still headed lower. Over the next 24 hours there are a number of Eurozone economic reports scheduled for release and chances are they will show that the economy continues to weaken. While German unemployment is expected to decline, according to the PMI report, August saw the slowest job growth in 5 months, signaling potential weakness in tomorrow’s labor market report. German consumer prices are likely to stagnate or decline and given this morning’s drop in German consumer confidence, economic, consumer and business sentiment are likely to have weakened this month. Another round of soft reports could be all that is needed to revive the downtrend in EUR/USD.

Buyers Still Attracted by Pullback in Dollar

Although the U.S. dollar traded lower against all of the major currencies today, its losses were limited because the pullback is still attracting buyers as the dollar ended the day well off earlier lows. Considering that there were no U.S. economic reports on the calendar, the decline has been largely attributed to month end profit taking. Of course, the dollar also enjoyed a very nice rally over a short period of time so a pullback from overbought levels would not be unusual and in fact expected. We would not be surprised if there was a deeper pullback in USD/JPY to 103.25 / 103.50 but for the most part, we expect the uptrend to remain intact. Meanwhile the NASDAQ hit a fresh record high today but ended virtually unchanged along with the S&P 500 and Dow Jones Industrial Average. Revisions to Q2 GDP are scheduled for release tomorrow along with the weekly jobless claims report and pending home sales. Jobless claims are expected to remain low and pending home sales will most likely rebound after falling in June. Revisions are often made to the U.S. GDP report but they are difficult to handicap. Economists are looking for a small downward revision and if they are right, it would provide a good excuse for further month end profit taking.

USD/CAD Extends Losses After 1.10 Rejection

USD/CAD continued to trade lower after rejecting 1.10 on Tuesday. The sell-off in the currency pair was driven entirely by the Burger King – Tim Hortons deal. Both boards have now approved the $11.4 billion merger, which will involve a major M&A flow in favor of the Canadian dollar. According to the terms of the deal, Tim Hortons shareholders will receive 65.50 Canadian dollars in cash and 0.8025 Burger King shares for each Tim Horton share. In order to pay for this deal, Burger King will need to convert a tremendous amount of U.S. dollars into Canadian dollars by the time the deal closes early next year and the prospect of this currency flow is the main reason for the broad based strength in the Canadian dollar. We continue to expect USD/CAD to decline especially since we are looking forward to a few positive Canadian economic reports this week. Canada’s current account balance is scheduled for release on Thursday followed by GDP on Friday. Meanwhile the New Zealand and Australian dollars also traded higher despite the drop in NZ food prices and decline in iron ore prices. NZD received quite a bit of support from the news that Fonterra will be entering a joint venture with Chinese baby food manufacturer Beingmate to meet the growing demand for infant formula. As our colleague Boris Schlossberg pointed out, “The investment of more than 500M suggests that Fonterra may be able to smooth out its delivery problems and also indicates that its stream of income from China – which is a significant contributor to New Zealand economy is likely to remain in place.”

Outlook for EUR/GBP

The rebound in sterling today should not catch our readers by surprise as we have been calling for stabilization or a near term bottom in the currency pair since Friday. With no U.K. data released overnight and nothing significant scheduled for Thursday, a relief rally was natural after the deep sell-off in the currency. Of course we can’t quite characterize this as a relief rally until GBP/USD breaks above 1.66 because for the past 5 trading days, the currency pair tested and failed to close above this key level. The problem is that U.K. rates are falling at a faster pace than U.S. rates, making it difficult for the GBP/USD to gain any meaningful upside momentum. Ten year Gilt yields fell 7.7bp on Wednesday compared to a 3.7bp drop in 10 year Treasury yields. This decline puts U.K. rates below U.S. rates of the same maturity. Although it is not the first time that this has occurred, it is nonetheless negative for sterling. For this and other reasons, we believe that the best opportunities to buy sterling are against other currencies such as the Swiss Franc (which we discussed yesterday) and the euro. Over the next 48 hours, a number of Eurozone economic reports are scheduled for release and most of them will probably be weak, fueling speculation of additional stimulus from the ECB next week. At the same since we don’t expect much from the U.K. for the rest of the week so if EZ data surprises to the downside, EUR/GBP should slip towards 79 cents.

USD/JPY Rally Stalls after 7 Days of Gains

After 7 straight days of gains, we finally have a pullback in USD/JPY and that is exactly what we think today’s move represents, which is a normal correction within a broader uptrend. U.S. 10 year Treasury yields resumed their slide but the impact on USD/JPY should be limited by the market’s voracious demand for U.S assets. The decline in USD/JPY did not stop most of the Yen crosses from extending higher. No Japanese economic reports were released overnight and this evening, we only expected the Ministry of Finance’s weekly portfolio flow report. Thursday night is the big night in Japan so for the time being risk appetite will drive Yen flows. Meanwhile Prime Minister Abe Advisor Koichi Hamada said the government could soften the blow of future tax increases by raising it gradually in 1% increments rather than a single hike. In April, the government raised the sales tax to 8% from 5% and in October 2015, they are expected to raise the tax to 10%. The final decision on this would probably be made later this year after the Cabinet overhaul. Hamada recommends raising the rate by 1% in October of next year and then another 1% sometime after that. He also argued that a “drastic corporate tax cut” could attract foreign investment and revitalize the economy – Abe has planned to lower the corporate tax rate but no details have been decided.