DB FX Daily: Will CBs Acknowledge the Shift in Market Sentiment?

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FX Daily: London
Will CBs Acknowledge the Shift in Market Sentiment?
Today's Key Data and Events

SEK Sweden core CPI for July, -0.2% m/m 1.1% y/y expected (7:30 GMT)
NOK Norway manufacturing output for June, 0.2% m/m expected (8:00 GMT)
EUR German IP for June, 0.7% m/m 5.3% y/y expected (10:00 GMT)
USD US Q2 non-farm productivity/ULC, 2.2/2.3% q/q expected (12:30 GMT)
USD FOMC rate decision, no change in rates expected (18:15 GMT)

Upcoming Event Risks

Aug 8 RBA decision, BoE Inflation Report
Aug 13: Japan Q2 GDP
Aug 15: Norges Bank rate decision
Aug 23: BoJ rate decision
Aug 31: Jackson Hole Symposium

Over the past year, the Fed has left rates at 5.25% and has consistently expressed that its main concern remained inflation. That said, the past few months have seen a softening in the Fed's tightening bias, helped by the apparent moderation in core inflationary pressures and the ongoing adjustment in the housing sector. With the recent turn lower in US data surprises combined with the volatility in financial markets, another softening of the language would likely not be a significant surprise to the market, judging by the sinking yields in late 2007 Fed funds futures. . The chart at left below tracks recent EUR/USD moves around FOMC statements which have been fairly well contained given the relatively small alternations to the outlook in 2006/07. But with the market now leaning towards the risk of lower US rates and the Fed holding a steady over the past year, perhaps the risk of short USD squeeze has increased should the Fed lean against building market expectations for rate cuts.

We don't see the recent bout of market turmoil as being sufficient to stay the RBA's hand in the wake of the higher-than-expected Q2 CPI reading (and a long-standing strong domestic activity case for action), and hence we look for a 25bp rate hike to be delivered by the RBA overnight. While a rate hike is expected by us and the market, the very front end is not fully priced for the move so the announcement could provide some support to the AUD. That said, given the ongoing degree of risk aversion in markets we would prefer to play this AUD strength through a long AUD/NZD position. Following the Fed and RBA, the Bank of England Quarterly Inflation report released early on Wednesday has a track record of moving the market with an average GBP/USD range of 175 pips on release days since 2004. UK economic data has been mixed of late leaving rate expectations little changed and hence sterling rate support ample (see chart at right below). While not expected just yet, any sign of a softening in the Bank of England's stance could have the potential to weigh significantly on GBP/USD given the strong correlation with rates over the past couple of years.


Trevor Dinmore
Strategist
(+44) 20 754-71796
[email]trevor.dinmore@db.com[/email]