Risk aversion eases towards the end of the week after a couple of days that saw equities and the Dollar taking quite a hit. The US currency has taken the brunt of the hit as investors seem to believe that the sell-off in stocks is purely a US story since the Fed is the only central bank raising interest rates at this point but we think that there's a broader story here. The Euro continues to benefit from Dollar's decline but the Pound fails to follow suit. Gold rallied more than $30 on risk aversion flows yesterday to breach the top end of its sideways pattern while Oil proceeds lower.
The Dollar has been under pressure this week on the back of traders' portfolio reshuffling that saw outflows from equity positions into fixed income instruments dragging 10-year yields lower. At the same time, yesterday's inflation data from the US didn't help the greenback at all when it missed expectations, suggesting that consumer prices might decline towards the end of the year, removing the need for a faster tightening pace from the Fed. Does that mean that the Dollar is in for a bearish Q4? We don't believe so but clearly the bullish bias the Dollar enjoyed last month has diminished somewhat and new catalysts are needed.
Would these be next week's Retail Sales data and FOMC minutes? It is possible as analysts expect a significant rebound in consumer spending after last month's weak figures while the Fed's rhetoric should not deviate from the usual “more gradual tightening is needed” line. Both factors would be positive for the Dollar and with Fed's comments pretty much priced in, it's the retail sales data that will make or break the Dollar at the start of the week. Dollar/Yen has defied our call for a rebound after hitting 113 and has now dipped as low as 112 and, at least from a technical perspective, this is a good area for a move higher to start developing. We think that if the Dollar pulls higher from here then 113 is our next target.
The Euro reached 1.16 on the back of Dollar's weakness but now that prices are entering a resistance zone it might be difficult for the shared currency to extend its gains. Italy's troubles might have been pushed to the background but haven't been resolved so we'd rather be cautious at this stage, especially if Dollar starts moving higher from here, with 1.1570 the short-term support level. The Pound was not able to extend its rally yesterday and instead tread water around 1.3250 which appears weird given Dollar's outflows. The key catalyst here is obviously the Brexit negotiations and after a handsome rally this week traders may look to bank their profits ahead of the weekend, which may push prices towards the 1.3180 area.
Gold exploded to the upside yesterday recording more than $30 of gains as the combination of a weaker Dollar and increased risk aversion created the “perfect storm” for the yellow metal. What's interesting though from a technical perspective is that prices have now breached the upper end of Gold's previous consolidation zone and the question becomes whether more gains should be expected. If prices hold above the $1,210 level then the break will be confirmed and an extension towards $1,235 might be seen; however, we also need to be wary of a swift Dollar comeback that could negate the breakout.
Equities are trending higher after a few days in the red. Yesterday was a turnaround day for stocks especially after the US CPI reading missed its mark; investors now seem to be pricing fewer than 3 rate hikes between now and the end of next year and that helped equities recover from their losses. This morning, futures in Europe and the US are indicating a strongly bullish opening bell so the end of the week should be a positive one.
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Written by Konstantinos Anthis, Head of Research