Positive US Economic Data Sees USD Become the Growth Trade as Dow Jones Hit All time Highs

Better than expected UK PMI Services, stronger consumer spending out of Australia and a relatively sanguine all helped to drive risk currencies higher and both cable and Aussie rebounded from the the lows set at the start of the week and European equity bourses posted strong gains on better investor sentiment.

Cable shot up to test the 1.5200 barrier in the wake of better than anticipated UK PMI Services report which printed at 51.8 versus 51.0 eyed. The index rose to a 5 month high while employment and confidence readings reached their best levels in 9 months. The PMI services number stood in sharp contrast to the UK Manufacturing and Construction reports this month which showed continued contraction in both sectors. Fortunately for the UK economy the services sector dwarfs both manufacturing and construction providing some optimism to investors that Q1 GDP may not contract for the second quarter in a row.

Data today will likely confirm that euro area GDP contracted at its sharpest pace since 2009 during the final quarter of 2012, as the economy strained under fiscal austerity measures. Lloyds TSB forecast GDP fell by 0.6% q/q, unchanged from the initial estimate. This represents the fifth consecutive contraction in economic activity within the single currency area. Weakness in the real economy will be a key area of discussion for the ECB when it meets tomorrow. Although Lloyds TSB think that a rate cut is unlikely, the release of the bank’s medium-term forecasts will likely suggest that downside risks to the economic outlook still persist. Lloyds TSB forecast the euro area will contract by 0.3% this year.

The better PMI Services reading also dovetails with stronger BRC report and the surprisingly robust labor data indicating that the slowdown fears regarding UK economy may have been slightly overblown. We noted yesterday that the PMI Services report was the last bastion of hope for sterling bulls and today’s beat should provide some support for the pair which found strong support underneath the 1.5000 level yesterday. With market still structurally short sterling, the pair may see further rebound as the day progresses.

The positive ISM data helped fuel the rally in equities with the Dow hitting all time highs, but the upbeat sentiment did not extend into the currency market where both EUR/USD and GBP/USD fell in the aftermath of the release. The dynamic in the currency market has changed radically with high beta currencies no longer receiving the benefit of risk flows.

As US economy continues to decouple from both the EZ and UK and as the differential in GDP performance becomes wider, the dollar is suddenly taking on the characteristics of the growth trade as currency investors buy the buck on positive US data. It will be interesting to see if this trend persists into the NFP report in which case both EUR/USD and GBP/USD could break their recent lows without any additional bad economic news from those regions.

The contents of this report are for information purposes only. It is not intended as a recommendation to trade or a solicitation for funds. The author(s) cannot be held responsible for any loss or damages arising from any action taken following consideration of this information.

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