Dollar firms on growth concerns, oil prices surge
The safe haven US dollar remains in high demand following weak global activity data and rising US Treasury yields. The US dollar index rose to its highest point since mid-March, dragging EUR/USD towards $1.07 and GBP/USD into the lower realms of $1.25. We’ve seen a modest rebound in both currency pairs this morning, but with equities poised to open lower and oil prices surging, pro-cyclical currencies may resume their decline.
Weaker growth conditions outside the US will continue to play into the dollar’s hands. The strength of the US economy so far in 2023 compared to other advanced economies has increased hopes of so-called “soft landing”, but China’s lacklustre recovery and Europe’s ongoing economic woes continue to taint global investor sentiment. The US dollar is benefiting not only from safe haven flows, but also rising yields amid US economic resilience in the wake of higher interest rates, giving rise to the “higher for longer” interest rate narrative. That said, Federal Reserve (Fed) Governor Christopher Waller took a relatively dovish steer speaking yesterday about the Fed’s next policy move following a spate of mixed economic data. Today, all eyes are on the ISM services PMI reading, which is expected to slow but stay in expansion territory. Elsewhere, surging oil price may also support the dollar as amid the US energy independence and its net exporter status.
Until activity actually stalls in the US, there is no imminent reason for the Fed to consider rate cuts and that’s why we’re seeing the long-end of the yield curve climb as markets adjust for structurally higher rates, which is supporting demand for the dollar.
A test of $1.25 brewing?
Relative US economic strength is why the US dollar is dominating, and the pound is on the back foot with eyes on the key $1.25 handle as a potential downside target this week. Saudi Arabia and Russia extended their voluntary supply cuts to the end of the year, which has sent oil prices surging, increasing fears of stagflation in the UK due to its energy dependency.
Sterling weakness may be short-lived as UK-US rate differentials and higher-for-longer UK rate expectations should favour the pound. With only the Bank of England (BoE) expected to hike in September, GBP/USD may reverse recent weakness as traders focus on widening yield-differentials again. BoE Governor Andrew Bailey will be speaking later this afternoon and amid persistently strong UK wage growth keeping pressure on services inflation, we expect Bailey to remain hawkish, which could limit sterling’s recent slide. The interest rate outlook alone may not be enough to entice investors into buying pounds again though. The UK growth outlook will need to improve too. With private output contracting in August for the first time since January and forward-looking indicators in the services PMI survey remaining downbeat, the outlook doesn’t look promising.
Moreover, from a technical standpoint, if GBP/USD closes below its 100-week moving average and below $1.25, then the door could swing open to $1.23, which is around the key 61.8% retracement of the 2023 low to high swing.
Seasonality favours the euro
Disappointing data from Europe continues to weigh on the euro. This morning, data revealed that German factory orders plunged 11.7% month on month in July, much worse than the 4% fall expected and the steepest pace since April 2020. GBP/EUR is holding above €1.17 having risen about 1% in five trading days. But will the euro soon recover as history suggests?
We do expect global economic momentum to remain subdued in 2024, and this weak growth environment might limit the euro’s potential to the upside. Still, the improvement of sentiment in Europe and a potential economic uptick in the second half of 2024 could support a marginal appreciation of the common currency. Seasonality trends also suggest European data tends to outperform in the second half of the year and historically FX trends show that EUR/USD has risen, on average, 0.5% in the month of September since 1991, whereas GBP/EUR has fallen 0.75%. Seasonality trends should not be considered in isolation though and the stickiness of inflation and weakness of European economies continue to raise stagflation fears, which are weighing on the euro.
In the near term, the dovish tilt from inflation expectations data supports the notion that the European Central Bank will stay put in September, halting a sequence of nine consecutive hikes. However, still high core inflation means the decision remains close to a coin toss.
Oil prices soar 6.5% in a week
Table: 7-day currency trends and trading ranges
Key global risk events
Calendar: September 04-08
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*The FX rates published are provided by Convera’s Market Insights team for research purposes only. The rates have a unique source and may not align to any live exchange rates quoted on other sites. They are not an indication of actual buy/sell rates, or a financial offer.
