Dollar Remains Vulnerable As Equities Stabilise

GBP: Sterling takes hit on risk appetite decrease and unwinding of long positions

Sterling may remain under pressure as investors continue to be cautious after Monday's global market turmoil sent the currency lower, Monex Europe said.?

"While markets are no longer in full-blown panic and many of yesterday's moves have unwound, it is notable that European equities continue to trade under pressure this morning, while yields have moved in opposite directions."

Sterling was also being hit by an unwinding of earlier bets on its rising, or long positions, it added.

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EUR: Set for a move to $1.10

The rebound in the EUR:USD 2-year swap spread may stall around -100bp. That would be entirely consistent with EUR/USD trading above $1.10 even when factoring in the softer risk sentiment (as measured by global stocks performance).

As discussed earlier this week, markets may not take the hawkish re-adjustment in Fed expectations much further, while the same cannot be said about ECB pricing. The EUR OIS curve currently embeds 69bp of easing, which is largely a spillover from Fed pricing, as the latest inflation figures in the Eurozone pointed to risks that the ECB may skip a cut in September. Risks are undoubtedly skewed to 50bp as opposed to 75bp by the ECB in the three meetings until year-end. Looking ahead, we may see?EUR/USD test $1.10 before the US CPI event next week.

Elsewhere, we may see?a continuation of the rebound in Norway's Krone and Sweden's Krona among other high-beta currencies. NOK has particularly taken a major hit from the equity sell-off and has plenty of room to recover ahead of a Norges Bank meeting next week which may well fail to endorse the market’s dovish bets as policymakers may well focus on helping the battered currency.

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USD: Softer rate position

Japanese equities continued to rebound this morning and futures are pointing to a positive open in US and European equities, with the latter having been a laggard in the recovery so far. From a purely macro angle, markets remain cautious about big risk-on rallies before the key US CPI risk event (next Wednesday) is cleared. That said, a stabilisation after the big correction around the weekend should be enough for most FX pairs to start reconnecting with rate spreads and fundamentals.

From this perspective, the Dollar looks vulnerable. Markets may be reluctant to take the year-end Fed policy rate much above 4.50%; that’s because 100bp of easing is probably linked to US macro, with anything extra (which has now been priced out) linked to expectations for some sort of intervention by the Fed to help the stock market.

That means the rebound in USD 2-year OIS rates to 3.75-80% may struggle to find much more momentum, and the Dollar may be left with a short-term rate advantage around 40bp lower compared to just 10 days ago. This could?drive the Dollar lower against most pro-cyclical currencies amid a potential further stabilisation in risk sentiment and a lack of market-moving data this week.

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