EUR CPI & GBP CPI What is Priced In?

Chinese data disappointment was not enough to trigger a broad-based rebound in the dollar, which continues to show some disinflation risk premium (i.e., short-term undervaluation). I’ll monitor some US releases including building permits for June today, on an otherwise very busy day for Europe and UK with CPI coming in at nighttime for Sydney. In Australia, RBA minutes reiterated openness to another hike.

USD: No real benefit from China’s data disappointment

At the beginning of this week, there were concerns about the dollar and its potential vulnerability to the residual effects of the disinflation surprise. The data calendar was relatively quiet, and all eyes were on the upcoming FOMC meeting scheduled for July 26th.

Despite disappointing growth numbers from China, the reaction in the foreign exchange market was relatively calm. The AUD and NZD declined due to their high exposure to China, but the EUR/USD pair remained unchanged, even though European stocks underperformed.

The lack of significant gains for the dollar, considering the deteriorating sentiment towards China, suggests that investors are currently hesitant to build up long positions in USD. However, it's worth considering that the dollar might be undervalued in the short term compared to some major currencies (except the Japanese yen, JPY). As a result, we might witness a convergence of the dollar with its short-term drivers, leading to a potential dollar recovery. Nevertheless, this mis-valuation gap could also be closed by other market drivers.

EUR: Stretched short-term valuation

Yesterday, European equities didn't perform as well as US stocks, mainly due to disappointment in Chinese data. Normally, this kind of situation would lead to a weaker EUR/USD exchange rate. The weakness is attributed not only to the euro's positive outlook and the dollar's negative outlook concerning China's growth but also because EUR/USD tends to be highly influenced by the relative performance of eurozone and US equities.

Based on my short-term financial fair value model, EUR/USD appears to be overvalued by more than 3.0% due to its unusual movements. This suggests that the foreign exchange market is factoring in a disinflationary risk premium into the dollar, which goes beyond what is accounted for by interest rates and equity performance.

Today, the only significant event to monitor in the eurozone is the CPI release. Despite a rise in EUR/USD during morning trading, I believe that sustained gains beyond the 1.1300 mark might not be achievable at this moment.

GBP: Softer into the CPI risk eventAt the beginning of this week, the British pound has been more vulnerable compared to most of its G10 counterparts. The EUR/GBP exchange rate has gradually risen in the past few sessions, reaching the 0.8600 level. This increase in volatility is a result of global central bank tightening expectations shifting after the US CPI slowdown. Curves that had more room for a dovish repricing, such as the GBP, were affected asymmetrically.

Market participants are also adjusting their positions in anticipation of the upcoming release of UK inflation numbers scheduled for today. The CPI data will play a crucial role in determining whether there will be a 50 basis-point rate hike by the Bank of England in August. The prevailing market sentiment remains tilted towards the hawkish side, with current pricing suggesting a 44 basis-point increase in August and a total of 116 basis points overall. However, peak rate expectations experienced some volatility and were reduced by almost 15 basis points yesterday.

It is expected that EUR/GBP will likely maintain its overall support heading into tonight’s release of the CPI data.

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