Talking Points

  • U.S. Dollar: Benefits From Risk Aversion, Inflation Tops Forecast
  • Euro: ECB Casts Dour Outlook, All Eyes On Greece
  • British Pound: BoE's Weale Opposes More QE

Market participants showed a mixed reaction to the slew of data coming out of the world's largest economy, but the shift in risk-taking behavior should help to prop up the reserve currency as it benefits from safe-haven flows. The headline reading for U.S. inflation held steady at an annualized 3.6% for the second month in July, while the core reading for consumer prices increased 1.8% from the previous year to mark the fastest pace of growth since December 2009. However, the rise in initial and continuing jobless claims reinforces a weakened outlook for the U.S. as private sector consumption remains one of the leading drivers of growth.

The stickiness in price growth may ultimately lead the Federal Reserve to soften its dovish outlook for monetary policy, and the central bank may have little choice but to toughen its stance against inflation as price pressures continue to hold above the 2% target. In turn, we may see a growing rift within the central bank, but it seems as though there's a general consensus that we will see the tepid recovery carry into the following year as the FOMC preserves its wait-and-see approach. As the committee struggles to meet on common ground, the lack of coordination could further dampen the appeal of the reserve currency, but the greenback should continue to regain its footing in the days ahead as market participants scale back their appetite for risk.

The Euro fell back from an overnight high of 1.4451 and the single-currency may continue to trade heavy throughout the North American trade as the uncertainties clouding the economic outlook weighs on market sentiment. In response to the recent developments, European Central Bank board member Ewald Nowotny talked down the risk for a double-dip recession during an interview with an Austrian newspaper, but saw a danger of low grow paired with subdued inflation in light of the slowing recovery in the global economy. As the fundamental out deteriorates, we expect the ECB to keep the benchmark interest rate on hold at 1.50% for the remainder of the year, and the central bank could be forced to step up its efforts to strengthen the European financial system as policy makers struggle to stem the risk for contagion.

Heading into the end of the week, all eyes will certainly turn to Greece as the IMF, ECB, and the EU are scheduled to visit the ailing country on Monday, and the near-term outlook for the single-currency remains fairly bearish as it continues to trade within a descending triangle. As the EUR/USD failed to close above the 78.6% Fibonacci from the 2009 high to the 2010 low around 1.4440-60 during the previous day, the rally to 1.4516 may turn out to be a false break, and the exchange rate may continue to retrace the advance from earlier this month as fears surrounding the sovereign debt crisis continues to sap investor confidence.

The British Pound pared the decline to 1.6473 but the bullish sentiment underling the sterling may give out as U.K. policy makers turn increasingly pessimistic towards the real economy. Bank of England board member Martin Weale said underlying growth in Britain is likely to be 'somewhat weaker' than initial expected, but went onto say that third-quarter GDP figures 'will look better' than the growth figures release for the three-months through June during an interview with BBC radio. Although Mr. Weale scaled back his vote to increase the benchmark interest rate by 25bp, he opposed raising the asset purchase target, but we may see a growing shift within the MPC as policy makers continue to see a risk of undershooting the 2% target for inflation. In turn, the near-term advance in the GBP/USD may lose momentum in the coming days, and the exchange rate may consolidate within a broad range as the region faces a growing risk of a double-dip recession.