Euro’s Correlation with Risk Wavers, as Dollar Funding Status in Doubt

GBP/USD

The GBP/USD is back under pressure as broader risk aversion is dominating price action. Indeed, we have seen the pair’s correlation with risk trends increase to 0.34 from 0.28 a month ago as markets starting moving together following the Dubai debt scare. This has led to pound interest rate expectation losing its influence over direction, but that could change with the BoE rate decision ahead. If the central bank officially ends its asset purchase program we could see bullish sterling sentiment emerge as it would be the first step toward tightening.

BoE Interest Rate Expectations

BoE interest rate expectations have taken a turn lower with overnight index swaps currently pricing in 64 bps of rate hikes over the next twelve months which is down from 73.4 on December 4th. Flat industrial production in October has raised concerns that the current rebound in growth will slow weighing n the outlook for future yields. However, continued expansion in the service sector rising home prices and improving consumer sentiment had previously raised interest rate forecasts to their highest level in nearly a month. The BoE which has left the door open to adding to their asset purchase program will meet on Thursday to determine future interest rate policy. If policy makers officially bring an end to their QE efforts then we could see sterling support on the higher yield expectations.  To discuss this and trading ideas join the GBP/USD forum.

FOMC Interest Rate Expectations

U.S. interest expectations have resumed their downward trend as the impact from the labor report is starting to dissipate with markets now pricing in a 12.8% chance of a rate hike by March. The dovish comments from Chairman Ben Bernanke have lowered yield expectations. The central bank leader warned that household spending is “unlikely to grow rapidly” as credit remains tight and the job market weak. Despite November’s improvement, unemployment remains at a debilitating 10.0% which the Fed chairman says will lead to a moderate recovery pace. Bernanke would go onto say that the Fed is still looking at an extended period before beginning tightening as long-run inflation expectations are stable. 

Risk

Equity markets are back on the decline and the Dow is looking to test trend line support. A hold there could spell more upside potential for stocks. However, a break below the level exposes psychological support at 10,000. Expect risk trends to continue to influence EUR/USD price action and a break below 10,000 in the Dow would significantly increase the downside risks for both. To discuss this and other fundamental data join the Economics Forum.

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com