Europe rising on tide of better sentiment and ambiguous ECB, says JP Morgan’s Yates
US yields to rise faster than EU yields, according to Sara Yates, Global FX Strategist at JP Morgan Private Bank.
The USD outperformed nearly all other currencies last week as a run of
solid data kept the possibility of near term tapering alive in the market’s
mind. However, none of the data was spectacular. The substantial
positive surprise from the advanced estimate of Q2 GDP was largely
offset by a downward revision in the previous quarter. This meant that
the main positive news was the improved momentum at the start of Q3
than the amount of growth. Similarly, July’s jobs data was mixed, with
the nonfarm payrolls expanding by less than expected (+162K vs. +185k)
while unemployment ticked lower.
The FOMC statement also had a balanced outlook as it discussed the improvements in the labour market at the same time as giving more prominence to the downside risks such as weak inflation and the rise in mortgage rates. Therefore, while this news helped the USD push higher at the start of the week, the rally ran out of steam on Friday.
We continue to believe that a September taper is possible, but that the
Fed is likely to want further evidence that activity is firming first. We
believe this will keep the market focused on US data/events and the
performance of the USD/other currencies correlated. Longer term, as
US yields rise, we expect the USD to outperform many low yielding G10
The EUR held so tight to the USD’s coat tails last week that the cross end
almost flat on the week. This was an impressive result in a week of strong
USD performance. In our opinion, part of the EUR’s performance
reflected the on-going recovery in the euro area. For example, the euro
area manufacturing PMI for July printed a 2 year high at 50.3. Even
though this is only a smidgen above the neutral 50 mark, it marked a
welcome return to growth in the sector. We believe this turn in economic
conditions is helping to restore investor confidence in the region. As this
builds we expect the associated in-flows to help drive EURCHF towards
1.28 over the next 12 months.
The outlook for EURUSD is more complex, in our opinion. On one hand,
we expect improving euro area sentiment to support the EUR. On the
other, we expect US yields to rise faster than EU yields and support the
USD. Hence we have a relatively flat EURUSD forecast this year. However,
without further details from Draghi on what forward rate guidance will
look like, European yields are likely to follow US yields to a large extent
for now. This suggests near term upside risks for EURUSD.