The dollar was mighty yesterday with EUR/USD sinking into the 1.26s briefly yesterday morning before recovering throughout the day, the dollar index made a 4yr high as well. This while risk sentiment nosedived and the S&P 500 took out its month to date lows – thank you very much Apple! Both EUR/USD and the S&P appear to be in range-bound mode this morning as the market pauses to assess the damage. On the data front, overnight, Japanese inflation came in softer, it’s not been as low for 10 months. Anytime inflation slips in Japan, the market is likely to question the Bank of Japan’s resolve to achieve it’s 2% CPI target, and so with core CPI slipping to 1.1% in August from 1.3% in July people notice. We probably need a few more months of data before we can really assess the likelihood of the central bank achieving its stated aim. One would think that the substantial depreciation of the Japanese yen over the last year will give import prices a boost, so the key question is consumer demand which doesn’t seem to have fully recovered from the post consumption tax hike hangover. In any case the market will start to speculate on the central bank implementing additional stimulus measures to boost inflation. That’s a narrative that could assist further yen weakness. We shall see!
Revised US Q2 GDP growth numbers will be published today with some economists expecting an upward adjustment with construction one of the sectors likely to be making a stronger than previously calculated contribution. Strong US data is not considered great news these days, as it only reduces the justification for central bank stimulus, it will certainly be interesting to see how the market takes it.
Going back to currency markets, Emerging market currencies remain uniformly weak, and in particular currencies with resource focused economies have continued to suffer, and you don’t even need to look at developing market currencies to see that resource effect… AUD/USD and NZD/USD are classic examples. Dollar strength will leave a lot of collateral damage in the weeks and months to come! I shudder to think what corporates in resource rich developing economies are thinking if they borrowed dollars in the last few years (the interest rates at which they secured their loans must have seemed like a once in a lifetime opportunity), their continuing health will be very dependent on what their central banks do to counter changing Federal Reserve policy. But the continuing weakness of their home currencies is not helping them at all, let’s hope they hedge properly!
I’m expecting continuing dollar strength today, perhaps we haven’t had a mania of buying yet which will signal a short term top, it’s hard to tell with currencies, no one publishes volume stats. But my sense is that we could see further highs in the next few sessions, but mark my words, we’re very close to a bigger pause in this bull trend. I still maintain that the most recent moves, particularly in EUR/USD have been on suspiciously weakening momentum. As I mentioned earlier.. keep an eye out today on how the markets react if the GDP revision in the US is stronger than expected, that could tell us how extended the dollar already is.