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FX Week Ahead: Myopic Markets Hit USD On Inflation Miss

Submitted by Shant Movsesian and Rajan Dhall MSTA from fxdaily.co.uk

FX Week Ahead - Myopic markets hit USD on inflation 'miss' - rest of the major economies in focus ahead.

Once again, sluggish inflation takes a hammer to currency and we saw the USD turn back from a tentative recovery, which many still see as corrective against some of its major counterparts.  In comparative terms, we still feel the numbers out on Friday were not as bad as the pundits and markets perceived, but liquidity in the summer is not at its best at short term (reactive) flow gets the 'benefit' to some degree, with the usual suspects winning out - for now. The core rate held 1.7% - so that is 3 months in a row now, but the headline was up from 1.6% to 1.7% instead of 1.8% - small potatoes at the moment, but when looking at this as a global phenomenon, the impact was a little too one dimensional/sided, but next week will naturally tell us more.  

No surprise then to have seen the EUR shooting back into the mid 1.1800's again as the revival in Europe continues to draw in investors.  As we have seen in the sharp upturn in EUR/CHF, dormant cash on the sidelines is now being deployed, but at a pace which may unnerve the ECB who are ever wary of seeing another taper tantrum get out of hand.  Not that they have to worry about the rates market at the present time, with tensions between the US and North Korea driving money back into fixed income and safe haven in general, with the benchmark German 10yr now under 40bps again alongside the T-Notes pulling back further into the low 2.00%'s.  The spread has been widening again, but the near term correlation with EUR/USD has diminished (to put it politely) and after the very brief dip under 1.1700, 1.2000 is back on the radar.  

In the US, retail sales on Tuesday will be the primary data driver from the USD perspective, so price action may be a little more lively through the week rather than having to sit tight until the end of week determinants, with both payrolls and CPI traditionally released on a Friday.  On Wednesday however we get the FOMC minutes to dissect rhetoric on whether there is another Fed hike coming this year, alongside the now widely anticipated start of balance sheet reduction, which in itself has brought into question if another move on rates is required near term.  Fed members Kashkari and Bullard think not, but their dovish stance is widely acknowledged given increased air time of late.  

USD/JPY is naturally struggling also, but this is largely down to the repatriation flow hitting all JPY pairs at the present time, and enough to see 109.00 relinquished - the year's low ahead of 108.00 now on the horizon.  Downturns are continually bought up on dips, but the market is still significantly short JPY, and despite the clear rate differentials and BoJ yield control, sentiment is and will be overriding, and the sabre rattling between president Trump and North Korea maintains the real risk of a fallout which could take this pair down to 107.00-105.00 unless the situation de-escalates as everyone naturally hopes for.  Late Friday, Russia's Lavrov suggested they have a plan to coordinate with China to defuse the situation, and stocks gave this a tentative 'thumbs up'.  

Plenty of data out of Japan this week, as we get Q2 GDP very early on on Monday.  Industrial production and capacity utilisation out on Tuesday and the trade figures are out on Thursday.   

We also get industrial output data from China at the start of the week, along with retail sales and fixed asset investment, but unless we get any wild deviations from consensus, then minimal impact expected.  

Losses in EUR/JPY - under 129.00 - alongside those seen in some of the other EUR crosses, was perhaps a sign that we are finally due a correction in the single currency, but as we stated above, prospects look thin vs the USD, and even thinner against the GBP.  

Thursday's data schedule is the heaviest for Europe next week, with the latest inflation readings for EU wide July CPI to confirm 1.3% for the yearly rate; core standing at 1.1% so, let's see whether the market can put this into context. The ECB minutes later in the day can only offer the familiar lines of steady economic recovery amid damp inflation, but as we get closer to the September meeting, traders will be loath to go against the obvious narrative in play. German GDP for Q2 is on Tuesday, with the EU number on Wednesday - the former seen improving from 1.7% to 1.9% (yoy), while Eurozone growth as a whole is expected to remain unchanged at 2.1%.  

Inflation data out on Friday for Canada also, where consensus is looking for a pick up from 1.0% to 1.2% over July.  However, this will be overshadowed by the start of the NAFTA talks which begin on Wednesday, and may produce some jitters in the CAD pairings despite the recent signals that negotiations will be cordial at the very least.  Many of us still feel Mexico has more to be concerned about - I seem to remember president Trump alluded to this when we met with Canada's Trudeau!  

In the past week or so, we have seen the market reining on some of the recent CAD strength which really gathered pace in the aftermath of the BoC rate hike, and was bolstered by the bullish rhetoric on the economy, leading to further rate hike pricing which now looks to have been over-done.  USD/CAD stopped short of the 1.2400 mark, but this was only a modest 30-35 tick extension to the 2016 lows.  Had the moves had a little more give and take on the way down, we may have squeezed out levels into the mid 1.2300's.  Oversold, levels have moderated as they usually do, and we have also seen Oil prices struggling past $50.0 (WTI), so we may have more to correct under the present circumstances, but over the longer term, 1.2000-1.2200 remains the target - it's just how we get there.  

A quick look at USD/MXN, and we note some very similar price action, with the weekly charts showing a base just under 17.5000, but the upturn stalling above 18.0000.  18.4000 is the next level up top if the NAFTA talks threaten Mexico's export profile going forward.

The UK offers up the largest slate of economic stats next week, and again, inflation is on the agenda on Tuesday, but swiftly followed up by the employment report on Wednesday and then retail sales on Thursday.  The combination of these three metrics guarantee a choppy week ahead for the Pound, with the market now talking of parity vs the EUR, but first target for us on the upside is 0.9170-0.9250.  It has been a slow grind higher, but with the BoE clearly highlighting the concerns over the Brexit impact on economic activity ahead, the mood has changed drastically.  Indeed, it is hard to see why the market was so bullish given the overall impact of a 25bp rate hike at this point, and it has again taken the 'underwriting' of central bank viewpoint to sway sentiment.  

Cable has dropped from the upper 1.3200's to test under 1.3000.  The mid 1.2900's have held since as the USD has turned back en masse, but we expect selling to remain heavy unless the jobs report in particular shows market improvement.  CPI numbers have been distorted by exchange rate weakness, and retail has been bolstered by seasonal factors (tourism), so earnings will be bigger focus among the mix of data.  The low 1.2800's are the next level to watch here if we take another leg lower. 

The RBA minutes were a notable boost for the AUD near a month ago, despite the relatively cautious statement from the related central bank meeting at the time. Monday's release comes after a relatively neutral meeting statement seen at the start of this month, maintaining the caveats on wages and inflation, and we can see little to materially lift the AUD as currency strength is again highlighted - not as aggressively as on previous occasions, but likely enough to deter an all-out push for 0.8000 again.  That said, the RBA - and RBNZ - have both acknowledged the lower USD in all this, and this alone will defer any material depreciation here for now.  

As with the NZD, we expect a choppy correction to the downside from here, and the Australian employment numbers will influence the path  to some degree on Thursday.

NZD/USD has pushed down to 0.7250 or so, with the support ahead of 0.7200 coming in a little early and reclaiming 0.7300 after the USD sales seen Friday.   Retail sales in NZ released late Sunday, and we get the latest Global Dairy Auction results on Tuesday, but the latter has been a mere sideshow of late.

Swedish CPI on Tuesday to note, and we will see whether the strong growth data of late is feeding into asset prices.  SEK has found a strong base against its Norwegian counterpart in the 1.0300-60 area, so we may get some traction through 1.0200 next week, with the pullback in Brent dragging the NOK back.  Trade figures are the only release scheduled in Norway, on Tuesday also.