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Euro Near 5 1/2-mo Low. Dollar Pares Gains After CPI

The U.S. dollar traded higher against its major rivals overnight, hitting at five-week high against a basket of major currencies. Investors await this morning’s release of consumer prices for June, which is expected to show another monthly rise in inflation. While the inflation alarm bells are not likely to start ringing anytime soon, the steady rise in prices pressures does add to the case for the Fed to begin more clearly articulating its exit strategy from its long-held zero interest rate policy. A hotter than expected reading of CPI this morning would likely add to the greenback’s broadly improved tone.  

The euro slipped to a five and a half-month trough against the greenback overnight as an expected rise in U.S. CPI this morning should contrast the dangerously low inflation backdrop in the 18-member bloc and should highlight the divergent policy outlook between the Fed and the ECB. While no lending rate hike by the Fed is imminent, it is all but given that the next move for U.S. rates will be higher. In contrast, the ECB is expected to ease monetary conditions again at some point in the foreseeable future. The resulting yield advantage should keep the greenback biased higher. 

The Swiss franc, which had enjoyed broad support from a flight to safety across global markets, pared recent gains to trade at a five-week low overnight. The tense geopolitical backdrop undermined investors’ appetite for risk and supported traditional safe harbors like the franc. The euro’s recent drop below key support against the dollar dragged the Swissy lower with it.

The Aussie firmed against the greenback overnight after RBA Governor Glenn Stevens made no meaningful mention of the currency’s strength in a speech. The kiwi meanwhile was on the defensive ahead of the RBNZ’s Policy Board meeting late this afternoon.               

EUR: The euro slipped below key technical support against the dollar to trade near a five and a half-month low overnight. The single currency’s latest leg lower came ahead of this morning’s U.S. CPI report for June, which is expected to show another monthly rise in U.S. consumer prices. In contrast, the inflation backdrop in the 18-member bloc remains dangerously low and well under the European Central Bank’s 2.0% target. As a result, investors are once again focusing on the contrasting economic states of the U.S. and the euro zone and on the divergent policy outlook between the Fed and the ECB. The European Central Bank has kept the door to further easing, and possibly the outright purchase of assets by the central bank wide open. The euro should remain biased lower against the dollar but is unlikely to suffer a precipitous sell off until U.S. Treasury yields move decisively higher.   

GBP: The pound was marginally weaker against the greenback overnight with investors focused on tomorrow’s minutes from the Bank of England’s most recent policy meeting for direction. Given the growing list of positive U.K. economic reports, there is a risk that at least one member of the BOE voted for a rise in interest rates in early July. While such a scenario would likely send the pound broadly higher, even increased talk of an eventual rate hike by the BOE would keep the pound moving to the upside.  

AUD: The Aussie rose against the greenback overnight after the Governor of the RBA, Glenn Stevens, avoided talking about the overvaluation of the currency overnight. The strength of the Aussie had been a key concern for Australian policymakers earlier this year, and their abandonment of talking points about Aussie strength suggests a diminished risk of lower rates by the central bank. Separately, the kiwi was on the defensive ahead of an expected RBNZ rate hike this afternoon. While another 25 basis point hike by the RBNZ would be the fourth such move in as many meetings, a strong kiwi, benign inflation and a slowing dairy industry could result in a statement that signals an end to the bank’s policy tightening campaign.

USD: U.S. consumer prices rose by 0.3%(m/m) in June, exactly in-line with consensus forecasts. Ex-food and energy, CPI rose by a benign 0.1%(m/m), under the 0.2%(m/m) forecasts. Year-over-year, CPI was also cooler than expected both on the headline and core levels. The overall tame inflation backdrop will not add much pressure to the Fed to begin raising rates sooner than the current forecast for around mid 2015. So far, markets reacted by pushing both Treasury yields and the dollar lower in choppy trade this morning.