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The US Dollar Index reached a seven month high of 98.10 on Friday as both US Inflation data and the Retail Sales report beat expectations. The Greenback gained ground against the GBP, JPY and the CHF, but it was the move against the Euro which held the most technical significance going into the weekend.

The EUR/USD posted a NY close below 1.1000 for the first time since mid-June and looks likely to challenge key support at the 1.0950 level.

Thursday’s ECB meeting could possibly be an important pivot point in both the single currency and global equity markets. The idea that recent stock market valuations are heavily reliant on central bank stimulus could be tested if ECB chief Mario Draghi isn’t clear about the direction and composition of future EU monetary policy.

During the last four ECB meetings, there has been extreme volatility in both the currency and equity markets. The March 10th meeting saw the EUR/USD trade in a 400 point range while during the June 2nd meeting the single currency moved over 200 points higher on the day.

From an equity perspective, the German Dax dropped close to 600 points during the March 10th meeting and close to 250 points after the meeting in June.

Granted, the expectations for expansion on the QE purchase pool and extension of the duration of stimulus were much higher than forecasted for this week’s meeting.

However, we’ve seen a lot of conflicting headlines about the central bank’s thinking since the last meeting. Two weeks ago there was high level talk about tapering asset purchases and last week that was reversed with comments about extending and expanding the current level of stimulus.

During the last meeting, Mr Draghi expressed confidence about the resilience and positive outlook for the Eurozone economy but also lowered the staff growth forecasts and announced EU committees to evaluate additional stimulus options. With recent EU growth aggregates showing stabilization across the region, Mr Draghi has cause to express an optimistic tone.

The AUD/USD managed to recover into the weekend and retake the .7600 handle. The RBA minutes and the domestic employment report are the key data points for the Aussie this week. The early forecasts are for a bounce back in manufacturing and construction jobs to lift employment growth.

USD Index

With the prospect of a “hard Brexit” becoming a reality, market participants who had expected a “soft” Brexit, or no Brexit at all have had to adjust their UK price forecasts. The Sterling, for example, has depreciated more than 5% against the G10 currency basket over the last week and some analysts are calling for a  drop to parity against the USD by the end of the year.

Going back to late June, the GBP depreciation was considered beneficial for the UK following their decision to leave the EU. The orderly decline in the Sterling, alongside the easing of monetary policy and decline in 10-yr Gilt rates, would serve as an economic cushion to keep exports and equity prices steady while trade deals with other EU nations were being negotiated.

However, the recent down move in the GBP has not been orderly, nor has it coincided with lower yields across the UK Treasury curve. The 10-year Gilt yield has risen more than 20 basis points over the past week as the GBP/USD has dropped over 600 points. Granted, G-7 Treasury rates have risen across the board but nothing like the UK rates. The 10-year yields in the US and Germany have risen by 8 and 7 basis points, respectively.

In the equity market, the FTSE 100, which is now viewed as a currency play given the heavy weighting of companies that rely on foreign earnings, has returned over 13% for domestic investors this year, but has lost close to 7% for unhedged USD-based investors over the same period. Further, the return on the broader FTSE 250 is even worse with domestic investors up 3.2% and USD-based investors down 14.5% during 2016.

On balance, we believe it’s reasonable to expect that the uptick in yields and recent political developments will support the Sterling while carving out a base above recent lows. The GBP/USD has rebounded over the last two sessions. The recovery has been fuelled by UK Prime Minister May’s concession to allow Parliament to vote on the Brexit decision. Hearings before the British high court will continue until Monday, which could delay the process of when Article 50 is invoked.

The AUD/USD fell sharply after yesterday’s weaker-than-expected Chinese trade balance reports.

AUD/USD

FTSE 100