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The focus has been on economic data today as global PMI service sector data was released for September. The results were mixed – extremely weak data for the Eurozone and in particular Germany and France, while the UK and China also saw declines in their readings although their surveys remain above the key 50.0 level. The US was on top and there was a large rise in its survey.

The Eurozone economy shows no sign of turning a corner

The Eurozone PMI data in recent months suggests that the economy contracted by 1% in the third quarter, thrusting the currency bloc back into recession. The composite index has stayed steady around 46 since the beginning of the summer, so the continuation at this level suggests that momentum has not picked up and the currency bloc is looking weak as we start the fourth quarter. The service sector has suffered more than the manufacturing sector as austerity dampens domestic demand. As many countries expect to continue with harsh austerity programmes well into next year, the economic data could be mired in contraction territory for some time yet.

The UK saw its index fall to 52.2 from 53.7 in August and retrace nearly half of August’s surprise gain. This has weighed heavily on the pound and GBPUSD is below 1.6100 after this data. The pound has reacted strongly to positive data surprises recently, so this data miss could hit the pound hard. In the short term there is good support at 1.6050 then at 1.6025, while resistance lies at 1.6125. This pair has looked weak since it failed to break above 1.63 last month. If we continue to see GBP weakness then it could be a pre-curser to weakness in the euro and elsewhere, as it may suggest that the dollar is getting its groove back.

Rising prices not a problem for the Fed

The economic fundamentals are supportive of a stronger dollar today. The ADP private sector payrolls data surprised to the upside for September, coming in at 162k vs. expectations of 140k. The ISM non-manufacturing sector also rose to 55.1 in September, the highest level since March. The survey was very solid with gains for new orders and business activity. Employment was weaker at 51.5 down from 53.8 in August, but it is still above the crucial 50.0 mark. The sharp increase in prices paid was a concern. This component jumped from 64.3 in August to 68.1 in September, the highest level since February. This suggests that profit margins in the service sector could get compressed (bad news for stocks) in the coming months unless prices start to moderate.

Strengthening economic data and QE3

But what does this mean for the Fed and QE3? We would say not much. Firstly, the Fed does not seem that worried about inflation and could be willing to tolerate slightly higher prices in the near-term. Secondly, the Fed has linked QE3 to the employment rate. Since the ADP has dreadful predictive power when it comes to the NFP, today’s ADP data does not give us any insight into Friday’s labour market report. Thus, markets have been fairly confused today and traded mostly in ranges as the market waits for tomorrow’s ECB meeting and Friday’s payrolls report.

Look out for our research note on the ECB that will be sent out later today/ tomorrow. Draghi’s press conference is likely to be the highlight unless we get a surprise rate cut on the back of the dreadful economic data. But if Draghi remains  in wait-and-see mode as we expect then EURUSD could move back to the bottom of its recent range. Around 1.2820 – the 200-day sma, below here opens the way for a move to 1.2700.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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