FX Report 4 February 2016

After a relatively calm period, the Euro exploded into life against the dollar on Wednesday. Trading conditions remained subdued initially with pressure on the ECB increased by downward pressure on prices within the latest Euro-zone PMI data. The US ADP employment data was stronger than expected with reported private-sector jobs gain of 205,000 for January following an upwardly-revised gain of 267,000 previously.  In contrast, the ISM non-manufacturing index was significantly weaker than expected with a decline to 53.5 for January from a revised 55.8. Orders held firm, but the employment index was weaker and, significantly, there was also a deterioration in exports which had also been seen in the manufacturing data. There were important, dovish comments from New York Fed Governor Dudley who commented that financial conditions had tightened since the December Fed move to raise interest rates. A weakening global economy and further strengthening of the dollar could have significant consequences for the US economy and policymakers would need to take these factors into consideration if they persisted.  The comments overall triggered a further unwinding of rate expectations with markets now shifting towards not pricing in any further tightening for 2016 as a whole. Given the further shift in yield expectations, there was a fresh unwinding of long dollar positions built up over the previous few months and the US currency moved very sharply lower. The Euro initially pushed to the 1.0970 area and losses then accelerated with a Euro peak close to 1.1150 late in the European session before a correction back below 1.1100 on Thursday with any comments from President Draghi and other ECB officials watched closely.
JPY  The dollar was unable to gain any traction against the yen on Wednesday and retreated very sharply during the New York session. The weaker than expected ISM data and a further decline in US bond yields were important in undermining the US currency, especially with global equity markets also significantly weaker. US 10-year yields briefly hit the lowest level for 12 months, although there was a recovery later in the US session as oil prices moved sharply higher.  The yen also gained some support following reports that the negative interest rate would be limited to JPY30trn of current account deposits. The dollar overall dipped very sharply to lows near 117.00 before recovering as Wall Street erased losses.  Bank of Japan Governor Kuroda reiterated the commitment to reaching the inflation target while rejecting using exchange rates in guiding policy. The dollar was able to consolidate around 118.00 on Thursday as US bond yields recovered.
GBP  The UK PMI services-sector index was slightly stronger than expected at 55.6 for January from 55.4 which provided some net relief surrounding the outlook, although underlying business expectations deteriorated further for the month. Sterling gained some support from an easing of immediate political fears, although there were still important uncertainties surrounding the EU negotiations amid a lack of detail in proposals. Wider dollar developments then dominated with heavy US losses. Overall, Sterling pushed to four-week highs above 1.4600 while weakening beyond 0.7600 against the Euro. The Bank of England monetary decision and inflation report will be watched closely on Thursday with markets expecting a downgrading of growth and inflation forecasts. Although markets are expecting a dovish tone, much of this has been priced in following Carney’s comments last month and any impact will also continue to be offset by the shift in US expectations.
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