FX Report  28 October 2016

The Euro-zone money supply data was slightly weaker than expected while private loan growth was held below 2.0% in the year to September which will cause some concerns within the ECB that lending is not improving at a faster pace. The main feature during the European session was a sharp decline in German bunds as yields rose to five-month highs at 0.18%. A steeper yield curve would make it easier for the ECB to manage its bond-buying programme. Bank member Nowotny stated that the ECB would decide in December to what extent the bond-buying programme should be extended. The US durable goods data was close to expectations with a headline decline of 0.1% while there was an underlying increase of 0.2%. The pending home sales data was marginally stronger than expected while the jobless claims data was slightly lower than expected. Although the data was close to expectations, there was a a further sharp sell-off in the bond market with US yields moving to five-month highs just above 1.85% before some respite. The Euro lost ground in US trading with a retreat to below 1.0900 as US yields moved higher, although there was support below this level. The US GDP data is liable to spark further volatility on Friday, especially with position adjustment ahead of key events next week including the US employment report and Federal Reserve meeting. Markets are now placing a 78% chance that there will be an increase in Fed funds rates by the end of 2016, increasing the risk of a dollar correction if the data is disappointing.
The dollar found support close to 104.50 against the yen in the European session on Thursday and gradually strengthened during the day with yield trends extremely important. As US 10-year yields moved to the 1.85% area, there was further dollar strength and the US currency broke above the 105.00 level for the first time in three months.    There was a recovery in oil prices during the day which tended to curb yen support, although yield considerations dominated. Position adjustment will be important on Friday ahead of the Federal Reserve and Bank of Japan policy decisions next week. The latest Tokyo core inflation data was marginally stronger than expected at -0.4% from -0.5%, although the Bank of Japan’s core measure declined to 0.2% from 0.4% previously, maintaining pressure for further central bank easing. Immediate concerns surrounding the Chinese yuan faded slightly on Friday, despite a weaker central bank fix, and steady risk appetite during the Asian session helped keep the dollar above the 105.00 level.
The UK third-quarter GDP data was stronger than expected with a headline increase of 0.5% compared with expectations of a 0.3% gain. The Bank of England’s latest forecast assumed 0.3% growth for the quarter and there will be a further upward adjustment to forecasts, lessening the potential for another near-term rate cut, especially with a stronger than expected figure for the CBI retail sales data. From a longer-term perspective, there will be further structural concerns given that there was a 0.8% expansion in services while all other sector contracted for the quarter. Sterling strengthened immediately after the data on the shift in rate expectations and there was a sharp increase in bond yields on the day. The UK currency was unable to sustain a move above 1.2250 against the dollar and came under significant pressure with some evidence of month-end selling. Volatility will remain a threat on Friday given the US data and month-end demands with a dip in consumer confidence suggesting Sterling weakness may have unsettled consumers to some extent.
The Euro was confined to relatively narrow ranges against the franc on Thursday with resistance below 1.0850. The US currency was also blocked close to 0.9950 with a further challenge on parity out of range for now despite firm sentiment. There was a stronger reading for the UBS consumption index with gains led by strong car sales.  Global bond yields will continue to be watched closely and further upward pressure would tend to weaken the Swiss currency unless there is sustained selling pressure on equities in which case there would be the potential for some defensive franc support.
Regards All.

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