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Dollar Uninspired by Increasingly Hawkish Fed

- British Pound Responds to a BoE Tightening

- EUR/USD in highs above 1.3650

Though the pace of its retreat cooled this past session, the dollar nevertheless extended its decline. Despite a burst of volatility, EURUSD has kept to its range. Meanwhile, GBPUSD, AUDUSD and USDJPY all seem to be unfazed by their proximity to major technical levels. Under normal conditions, this would likely catalyze to a breakout or reversal in short order. Yet, we know current conditions are far from ‘normal’.

Putting aside the prominent fundamental themes and the enticing technical patterns, the overriding trait of the financial markets right now is activity. Volatility measures have been trending down for months in a systemic slump for fear and speculative opportunity. This is only exacerbated by the seasonal ‘summer doldrums’ which will be particularly draining next week with a Friday Independence Day holiday in the US encouraging liquidity in the financial center to drain well in advance of the actual market closure. It is difficult to normalize even extreme inactivity when there isn’t a market to fuel swings.

Market conditions aside, the dollar’s fundamental appeal improved materially this past session – at least on the relative monetary policy front. The Fed’s first rate hike will not come when the unemployment rate hits a certain level but when inflation pressures the central bank to remove accommodation. The central bank’s preferred inflation reading – the Personal Consumption Expenditures Deflator or PCE – showed a pickup in pace for the headline reading to 1.8 percent with a 1.5 percent uptick in the core.

These are still both below the central bank’s medium-term target of 2 percent, but St Louis Fed President James Bullard remarked that we would likely be above that level next year. In fact, he believed circumstances would necessitate a hike by 1Q 2015. Richmond Fed President Jeffrey Lacker proffered a hawkish view of his own – though not quite as aggressive. Next week, we will see the same high profile rate speculation with NFPs vs tepid market conditions with July 4th.

The Bank of England took steps to curb inflation, in the housing market. Normally, a move to halt price growth would be an interest rate hike; but such a blunt instrument would carry too much collateral damage for the central bank to implement now.

While that first benchmark rate increase is on the horizon, concern over the state of the UK housing sector (a bubble that will go unlabeled by officials) demanded a move now. BoE Governor Mark Carney announced a first step to limit loan-to-income ratios and to refuse loans that fail a stress test (a 3 percentage point rate increase). The stress test insinuates hawkish intentions; but this move also obviates a first hike to answer housing fears.

Following a quiet Asian morning of range-bound trade, the GBP/USD swang up and down amid comments from BoE's Bean, who suggested rate rises are fairly priced at present.

The GBP/USD rose to a daily high of 1.7040 before coming under pressure and retracing completely its intraday advance. The Cable slipped to fresh daily lows at the 1.7010 zone, and was last down 0.13% at 1.7015.

The GBP has been driven by BoE members’ comments over the last weeks, but now attention turns to the other side of the Atlantic as the US will release the nonfarm payrolls data Thursday - a day earlier of usual due to the Independance Day.

The single currency is posting meager gains at the beginning of the week, although enough to lift the EUR/USD to 2-week highs beyond 1.3650.

The pair left behind last week’s highs around the mid-1.3600s despite German Retail Sales disappointed investors in May, contracting 0.6% on a monthly basis and expanding at an annual pace of 1.9% vs. forecasts for a 0.7% and 2.1%, respectively.

The preliminary set of June’s Eurozone CPI figures headlines the economic calendar in European hours. Expectations call for the benchmark year-on-year inflation rate to print at 0.5 percent, unchanged from the prior month. Leading data from Markit Economics pointed to a pickup in regional price growth over the relevant period, with both manufacturing and service-sector companies citing higher oil prices as the culprit.

If this proves to foreshadow an upside surprise on today’s release, the Euro may move higher as traders reduce bets on a near-term expansion of ECB stimulus efforts. Technical positioning underscores the possibility of further EUR/USD gains ahead.

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Euro Set for Biggest Monthly Drop in Four Months on ECB

- Dollar Strengthens as Durable Goods Orders Gain in April

- British Pound Drops after Mixed Data, GBP/USD Faces 1.6800

The euro headed for its biggest monthly decline in four months amid speculation the European Central Bank will add to monetary easing next week.

A gauge of the U.S. dollar was poised for its first monthly advance since January before U.S. reports tomorrow that economists said will show initial claims for jobless benefits decreased last week, adding to signs the recovery is gaining ground. The Russian ruble was the best performer versus the dollar this month among 31 major currencies. New Zealand’s dollar dropped against all of its 16 major counterparts today as a measure of business confidence worsened. The ECB led by President Mario Draghi meets on June 5.

The euro was little changed at $1.3630 at 6:47 a.m. in London, having slumped 1.7 percent this month. It declined to $1.3613 yesterday, the lowest since Feb. 13. The shared currency bought 138.96 yen from 139.04 yesterday. The dollar traded at 101.94 yen after closing at 101.98 yen in New York.

Projections the ECB will lower borrowing costs to spur inflation have driven the euro to a three-month low this week. Twenty-three of the 39 economists surveyed by Bloomberg predict the central bank will cut its benchmark interest rate from 0.25 percent when policy makers gather next week in Frankfurt.

The dollar strengthened to a seven-week high after a report showed U.S. orders for durable goods unexpectedly rose in April.

The euro headed for the biggest monthly drop since January versus the U.S. currency after European Central Bank President Mario Draghi signaled yesterday that policy makers are ready to expand stimulus. Hungary’s forint extended losses after the central bank cut interest rates to a record low. The Turkish lira fell the most in a week as consumer confidence dropped. A gauge of volatility in Group of Seven currencies fell to almost the lowest in seven years.

Bookings for U.S. goods meant to last at least three years rose 0.8 percent in April after a 3.6 percent gain in the prior month that was stronger than previously reported, Commerce Department figures showed. The median forecast of 68 economists surveyed by Bloomberg called for a 0.7 percent drop.

Federal Reserve Chair Janet Yellen emphasized this month the U.S. economy is falling short of the central bank’s goals and still needs help, easing concern policy makers are preparing to raise rates. The U.S. has further to go to achieve full health, she said.

A light docket wouldn't keep the pound from volatility this past session. The sterling dropped against all of its major counterparts with the exception of the Swiss franc Tuesday. On the interest rate front, neither bond yields nor rate swaps were showing pressure on the buoyant BoE forecast.

On the data front, the docket was rather light. The third consecutive drop in monthly BBA home loans is a growing case for concern for a sector (housing) that has drawn a lot of attention, praise and skepticism. Another highlight was the CBI’s quarterly sentiment survey for the service sector. A record high is encouraging for both growth and hiring expectations – services account for three-quarters of UK jobs.

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