A coordinated risk-off rally in the global stock markets is taking its toll on currencies with investors fleeing towards safe haven instruments. The Dollar is not the one to gain though as Treasury yields continue to decline dragging the US currency lower. The European majors are taking advantage of this Dollar decline and score fresh gains while commodities take different directions with Gold pushing higher while Oil drops.
Investors' concerns about the on-going trade war between the US and China are forcing the major equity indices lower for yet another day and the sell-off is spilling over into the currencies' universe. China decision to lower their reserve requirements ratio was the first shot, followed by IMF's global growth warning and now, just a day ahead of the earnings' season, investors are growing nervous about the prospect of trade tensions curbing corporate results and forward guidance.
As such, what we're seeing over the past couple of days is a coordinated rally into Treasuries with yields continuing to decline from their recent highs; a signal that market participants are willing to exchange their higher beta equities for the low-yielding bonds as global growth and corporate profitability are now under threat. With US yields declining the Dollar has been on the back foot over the past couple of days and the question now becomes whether the broader outlook of the US currency changes.
We believe that there's an interesting combination of factors in investors' minds right now and today's US inflation reading will play a key role in deciding whether the Dollar can pick up pace again: on the one hand, US domestic growth is strong and recent data has proven that. At the same time, the Fed has remained hawkish signaling continued tightening, even in the face of Donald Trump's displeasure. Finally, the data from the rest of the global economies doesn't look attractive in order for investors to move into their currencies. On the other hand though, the rout in equities is pushing Treasury yields lower and given that we see an increased risk for more weakness in equities ahead, the Dollar may continue to suffer from even lower US bond yields.
As such, today's US inflation report might be pivotal in dictating Dollar's direction in the short to medium term as it could tilt the scales in one direction or the other. A strong reading will signal that inflationary pressures in the US are picking up and this will necessitate a response from the Fed. This will mean that the odds of 2 or 3 more rate hikes next year will increase and the Dollar will benefit - even partially as investors are clearing driven by the stock market sell-off right now. However, a miss in the report will take away the two key reasons explaining Dollar's recent rise: strong US data and a hawkish Fed. And this would spell disaster for the greenback.
In terms of price action over the next 24 hours, it will all depend on how stocks trade today - equity futures are trending lower - and the US inflation data. For the Euro, a continuation higher targets the 1.16 and 1.17 marks while a Dollar rebound will push prices towards 1.15; the Pound has hit 1.3250 on Brexit optimism and 1.33 is the next mark while support stands at 1.31 and finally, Dollar/Yen is testing the 112 support so a break lower opens up the 111.50 level while a pullback to the upside points to 113.
Gold benefited from Dollar's weakness and gained to hit $1,195 this morning and further gains can be seen if the US currency remains out of favor; the next area for us to focus is the $1,205 level. Oil on the other hand dropped significantly yesterday hitting $72. This means that the $72.50 support is now being tested and as we mentioned yesterday this will dictate the medium-term outlook: if prices manage to remain above it we would expect another test of the $73.50 resistance while a break lower exposes the $71.50 area of support.
Equities are clearly in the red and investors are very concerned over the toll of Trump's trade war on global growth but also domestic corporate profitability. Analysts expect a positive round of earnings for Q3 but weaker compared to Q2 and Q1 which suggests that forward guidance and expectations for year-end results may also be on the bearish side. As such, market participants are tempted to diversify their portfolios and look into Treasuries, hence the decline in their yield, which suggests more pain ahead. Futures on both sides of the Atlantic are in the red and we should be in for yet another bearish session today.
MARKET EVENTS TO WATCH
- US Consumer Price Index - 4.30pm
- U.S. Crude Oil Inventories - 7pm
All times are GMT +4.
Written by Konstantinos Anthis, Head of Research