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US dollar rebounds ahead of Fed minutes

It’s taken four days but US markets have managed to recover all of the losses seen in last Wednesday’s sharp decline as investors focussed more on the success of President Trump’s overseas trip and less on his domestic woes. The postponement earlier this week of today’s testimony of ex FBI director Comey is probably a welcome relief, but still points to a problem delayed.

Investors are once again focussing on the positives, and choosing to ignore the negatives yesterday of some pretty disappointing housing and manufacturing data, which were much weaker than expected.

Asia markets were able to shrug off a ratings downgrade of China by Moody’s the ratings agency this morning citing concerns about its financial strength due to its highly leveraged debt levels.

European stock markets in general had a fairly positive day yesterday, with the FTSE250 coming within 15 points of the 20,000 level, while the FTSE100 underperformed.

The DAX and CAC40 were boosted by some fairly positive manufacturing and services PMI numbers which appeared to point to an even better performance for the economy in Europe than we saw in Q1, as both French and German private sector economic activity hit a six year high.

More importantly there was also significant evidence inflation with input and output costs at multi year highs in both countries. This sort of economic outperformance will make it much more difficult for the ECB to justify keeping rates at their current levels.

President Mario Draghi to continue to insist that economic risks remain tilted to the downside as he stated at the end of last month. With economic indicators returning these sorts of numbers to continue to do so would strain the ECB’s credibility.

Monetary policy this loose is simply not necessary when confronted with these sorts of numbers, and perhaps helps explain some of why the euro has rebounded, particularly in light of German Chancellor Merkel’s recent comments on the weakness of the euro.

ECB President Draghi is due to give a speech later today in Madrid so it will be interesting to hear his comments about the strength of recent data, if any are forthcoming.

The US dollar also appears to have caught itself a bit of a break yesterday ahead of the release of the latest Fed minutes.

In the last week or so market odds of a June rate rise have fluctuated quite sharply, though the consensus still remains that it remains more or less a done deal. I still have doubts about that but the Fed do appear to have boxed themselves into a corner for a move in June, and one that they may find difficult to extricate themselves from if things do go a bit pear shaped in the next few weeks.

At its May meeting Fed policymakers insisted that the weakness in Q1 was transitory and while recent Q2 data has improved a little there have also been significant pockets of weakness and bond markets certainly aren’t pricing a move in June even if Fed funds are.

St. Louis Fed President James Bullard has already indicated that he feels the Feds hike timetable is too aggressive and Minneapolis Fed President Neel Kashkari dissented on a rate rise in the March meeting.

While it is unlikely that we’ll see any clues as whether the Fed will move in June or not, it is likely that the market will infer that the Fed remains on course to do so, despite no evidence that inflation is anything other than sluggish.

That being said these minutes are old and investors are likely to take more clues from the discussions about reducing the size of the balance sheet, particularly since Janet Yellen’s term is up at the end of the year, and will likely have one eye on her legacy.

In the UK the British Government raised its threat level to critical for the first time in ten years in response to yesterday's Manchester atrocity, meaning that another attack could well be imminent. This would see the prospect of soldiers on the streets at critical infrastructure points and railway stations.

EURUSD – having failed to overcome the 1.1265 area over the last two days we could be in danger of a slide back towards the 1.1020 area, after yesterday’s key day reversal. There remains significant resistance at the November highs around the 1.1300 area.

GBPUSD – having failed at the 1.3040 area four days in a row we run the risk of a pullback towards the 1.2840 area. A consolidated move through 1.3050 has the potential to target the 1.3320 area. Only a move below 1.2750 argues potentially back towards the 1.2600 area.

EURGBP – yesterday’s move to the 0.8675 area ran out of steam rather quickly, and could suggest we’re overdue a pullback towards the 200 day MA and the 0.8600 area. A break below the 0.8600 area could well open a return to the 0.8540 area and the 50 day MA.

USDJPY – having moved back through the 111.70 area we could well move back towards the 112.40 level. A failure to push back through here could see a move back to the 110.20 lows of last week.

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