01.03.23: China Recovery Narrative Key for Near-Term Sterling and Euro Moves against the Dollar
The latest Chinese data was stronger than expected as the PMI manufacturing index strengthened to 52.6 for February from 50.1 previously and well above consensus forecasts of 50.7 while the non-manufacturing index also strengthened to 56.3 from 54.4 in January.
The data sparked fresh optimism over a rebound in the Chinese economy.
Optimism over China would help underpin risk appetite to some extent and provide an element of support for European currencies amid hopes for a rebound in the global economy.
In this environment, the dollar would also tend to weaken.
OCBC currency strategist Christopher Wong noted; “The strong set of China PMIs breathed some life into the China reopening trade.”
There will, however, still be important reservations surrounding US inflation trends and the risk that the Federal Reserve will have to act more aggressively to increase interest rates.
These fears will undermine risk appetite and support the dollar.
The US data releases will be very important over the next two weeks.
There is scope for limited short-term optimism, but caution will still be an important element with flips in sentiment.
ING commented; “Financial markets are caught between the two narratives of a softer landing (helped by China’s reopening) and sticky inflation keeping policy rates higher for longer. That will probably keep bond markets on the back foot and FX markets volatile in ranges.”
The Pound posted further strong gains in Europe on Tuesday with further optimism sparked by the new UK-EU trade agreement to revise the Northern Ireland protocol.
The Pound to Dollar (GBP/USD) exchange rate posted 1-week highs just above 1.2140.
There was a sharp reversal after the New York open as equities moved lower and the dollar secured significant month-end buying.
GBP/USD dipped to near 1.2020 before a recovery to above 1.2050 on Wednesday.
The Pound should draw an element of support from optimism over a stronger Chinese economy, especially if risk appetite can hold firm.
The focus will switch back towards monetary policy on Wednesday with scheduled comments from Bank of England Governor Bailey.
Dovish rhetoric and a push back against market expectations would tend to put the pound under renewed selling pressure.
There will, however, be support from the slide in gas prices and growing expectations that the government will boost energy-support measures for the second quarter.
At this stage, there should be sold GBP/USD buying on dips towards 1.2000 as long as the global risk trends are relatively benign.
The latest French and Spanish inflation data releases were slightly higher than expected which maintained concerns that the Euro-Zone release on Thursday will also be higher than expected.
The German data will be released on Wednesday.
The Euro to dollar (EUR/USD) exchange posted gains to highs on 1.0640 on Tuesday, but failed to hold the gains with notable selling into the fix and lows around 1.0575.
EUR/USD recovered to just above 1.0600 on Wednesday.
Hopes for a rebound in China should provide an element of Euro support and gas prices dipped to fresh 18-month lows on Tuesday which will also underpin the Euro.
US consumer confidence dipped to 102.9 for February from a revised 106.0 previously and well below consensus forecasts of 108.5. There was an increase in the current conditions component but this was offset by a sharp downgrade in the expectations component to 68.7 from 76.0 in January.
The expectations component has been below the 80 level for 11 out of the last 12 months which, according to the Conference Board, often signals a recession within the next year.
Month-end elements had an important impact on Tuesday, but the overall economic conditions will dominate during March, especially given a crucial impact on Fed expectations.
There will be unease over growth trends, especially in manufacturing, but there are also concerns over persistent inflation, especially in the services sector.
This uncertainty will tend to have mixed implications for the dollar with choppy trading likely.
According to Rabobank global strategist Michael Every; “We see the Fed going to 5.5%, with a growing risk of 6%. The Fed is hiking. Others can’t follow or match. The dollar will soar.”
The latest Australian data was weaker than expected with fourth-quarter GDP growth held to 0.5% compared with expectations of 0.8% while the monthly inflation rate dipped sharply to 7.4% from 8.4%.
The Australian dollar dipped sharply after the data, but rebounded strongly after stronger than expected Chinese business confidence data.
The Pound to Australian dollar (GBP/AUD) exchange rate jumped to 2-month highs around 1.8030 before a sharp retreat to 1.7825.
Chinese hopes also supported the New Zealand dollar.
The Pound to New Zealand dollar (GBP/NZD) exchange rate posted 4-month highs around 1.9675 before a slide to 1.9350.
The Pound to Canadian dollar (GBP/Cad) exchange rate also failed to hold 1-month highs around 1.6520 and dipped to 1.6400.
There was also further high volatility in the yen during the day.
The Pound to yen (GBP/JPY) exchange rate hit 2-month highs at 166.00 before a retreat to 164.20.
The Pound to Swiss franc (GBP/CHF) exchange rate also hit 1-month highs at 1.1360 before settling around 1.1325.
The US will release the ISM business confidence data for the manufacturing sector.
Regional surveys this month have been generally weak and markets expect that the index will remain in contraction territory below 50.0.
Very weak data would increase fears over the manufacturing outlook and the wider economy and could dampen Fed expectations, although the prices component will also be important.
The Friday services-sector data will also have a notable impact.
Comments from Fed officials will continue to be watched closely.
Overall trends in equities will remain a key element for currencies during the day with portfolio adjustments at the start of the new month.
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Tim Clayton
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