EUR's Noose Tightens

It's not a surprise to the forex landscape that market movement remains somewhat beholding to Central Bank rate announcements, and less so to geopolitical and fundamental risks. This week we still have two of the biggest Central Banks to report – ECB and BoE. What is currently happening in the forex space has been the traditional setup for the past 18-months. The low rate, low volume structure supports the traditional “carry” trade, in this case mostly antipodean currencies funded by cheaper EUR's. Since last week, dealers have tried to turn over the market in favor of the dollar supported by yield differentials. However, that has been a tough act to follow through on just yet.

The USD sits atop key levels across the majors; some at yearly highs supported by improved U.S. fundamentals and a less dovish Federal Reserve. Presently, the mighty dollar is also picking up against emerging currencies, and with weaker emerging market fundamentals, it's leaving that currency segment rather exposed. However, the Feds non-inflationary concerns, coupled with spare capacity in the labor market, is pushing investors to take a backseat until the Jackson Hole Economic Symposium in late August to gauge the Fed's current thought process. By days' end, investors should be in a position to better align their expectations on the pace of rate hikes for the foreseeable future.

Geopolitical tensions dominate

Nevertheless, investors should be expecting current geopolitical tensions in Ukraine to keep their risk appetite somewhat in check. This morning's German June factory orders plunging, coupled with the UK's June Industrial Production coming in below expectations (+0.3% vs. +0.6%e) and Italy backing up again into a technical recession, has many seeking sanctuary on the sidelines. Euro bourses are taking a beating, amid renewed concerns over the conflict in Ukraine and the toll it is taking on the Euro-regions economy. The DAX is currently trading near its five-month low – not a surprise, given Germany's deep trade and energy links with Russia.

Italy enters technical recession

This morning's disappointing German factory orders highlights the underlying risks to the European economy. After a -1.6% fall in May, Germany registered a -3.2% decline in June. The headline was weak, while some of the details were not so bad, nevertheless, in the current “tit-for-tat” EU/US/RUS sanction war, the rest of us will see this as an a reason to worry about the German/Eurozone growth outlook. Data like this cannot but hurt the EUR (€1.3358).

Aside from the potential interest rate differentials, investors are beginning to price a negative impact from implementing further Russian sanctions. Not helping the EUR's cause this morning is the unexpected negative Italian Q2 GDP number (-0.2%). Italy's is the third largest Euro-zone economy and has now fallen back into a ‘technical' recession. Investors should expect this to be a focus in Draghi's Q&A tomorrow after the ECB rate announcement. Safer haven trades will continue to put pressure on German Bund yields (+1.15%) – market will be looking to test the historic low yield of last week (+1.11%).

BoE MPC meet starts today

Reports from Ukraine will undoubtedly keep the market on its toes. Any signs of escalation and the market will be seeking sanctuary in the traditional assets like gold, Yen, Dollar and CHF. Even the pound cannot make a go of it this morning (£1.6827). UK factory output rose at a weaker pace than expected in June (manufacturing +0.3%, m/m or +1.9%, y/y and industrial +0.3%, m/m or +1.2%, y/y). It should not be considered too much of a surprise and certainly falls in line with the subdued Eurozone IP in recent months over tensions in Ukraine and the Middle-East. The Office for National Statistics has cut its estimate for Q2 industrial output following this morning report. They now estimate production expanded +0.3% in Q2, rather than +0.4%. The IMF still considers the UK to be the fastest growing “advanced” economy this year and reason enough why many expect the BoE to be the first to hike rates by year-end. The MPC starts its two-day meeting today and a no rate decision is expected tomorrow, however, market is looking to gage the strength of dissent or ‘hawks' – maybe we get to see more “tightening talk.”