Resistance to Dollar Strength Is Futile

The U.S. dollar continues to perform strongly against various currencies, driven by a consistent series of better-than-expected U.S. economic data. This suggests that the Federal Reserve is unlikely to shift away from its hawkish monetary policy stance. Notably, resistance to the strong dollar is diminishing, especially evident in China, where a higher USD/CNY fixing indicates that the People's Bank of China may be more accepting of renminbi depreciation.

USD: No reason to unwind dollar longs.

The U.S. dollar is holding near its highest levels since March, fuelled by consistently positive U.S. economic data. After the above-expected ISM Services index earlier in the week, the weekly initial jobless claims report also showed a drop to the lowest levels since February, challenging the notion that the U.S. labour market is easing. With strong economic activity persisting, the market appears more inclined to entertain the idea of the Federal Reserve delaying a rate hike in September but potentially raising rates later in the year. This postpones the possibility of a Fed easing cycle, which keeps the dollar strong for an extended period.

The dollar's strength is becoming a concern for other countries, notably Japan and China. Japanese officials are considering intervention in the USD/JPY exchange rate, particularly in the 148-150 range. Meanwhile, the People's Bank of China (PBoC) allowed for a higher fixing in the onshore USD/CNY rate, dispelling the notion that there's a specific USD/CNY threshold at 7.35. USD/CNH is now trading above that level. Upcoming Chinese CPI data and a PBoC rate decision, which includes the one-year lending rate, may keep expectations alive for further rate cuts, potentially weakening the CNY/CNH and keeping emerging market currencies under pressure while supporting the U.S. dollar.

Investors appear hesitant to reduce their dollar holdings, suggesting that the U.S. Dollar Index (DXY) will likely remain bid around the 105.00 level.

EUR: Staying soft.

EUR/USD remains fragile as U.S. data remains strong, and news out of the eurozone and China continues to be bleak. We mentioned earlier this week that higher oil prices could potentially weigh on the euro. The focus today switches to natural gas, as it was confirmed that LNG workers in Australia went on strike on Saturday, leading to higher natural gas prices. This development further complicates matters for Europe.

Regarding this week European Central Bank (ECB) meeting, the market is currently pricing in only an 8% chance of rate hikes. There's also speculation that the ECB might raise the main refinancing rate (currently at 4.25%) while keeping the deposit rate unchanged at 3.75%. However, such a move may not provide significant support for the euro.

The EUR/USD pair is expected to have a relatively quiet session on this Monday, with no compelling reasons for it to rebound. Pressure could mount for the pair to test levels below 1.0700, especially if there are developments that drive USD/CNH to the 7.40 area.

In other currency news, the Polish zloty is likely to remain weak following a dovish press conference from the National Bank of Poland from Thursday. This indicates that the zloty may continue to face headwinds in the near term.

GBP: Cracks appearing in the BoE tightening story.

Bank of England (BoE) has received favourable news regarding price expectations from the corporate sector. This development has contributed to a re-assessment of the BoE's tightening cycle. The market's expectation for the policy rate peak, initially priced for next February, has now moderated to 5.60%, compared to the near 6.50% levels anticipated just a couple of months ago. This shift in expectations explains why EUR/GBP is currently trading near 0.8570, rather than near 0.84, despite the softening euro.

The expectation is for EUR/GBP to continue drifting within the 0.85-0.86 range leading up to this Tuesday's significant release of July compensation data. In this context, some investors may be on the lookout for a downside surprise in the data.

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