FX: Watching Paint Dry?

The foreign exchange market is becalmed. No, seriously. The euro has been confined to less than a 20 pip range (1/5 of a penny), and the dollar has not moved out of a 15 tick range against the yen (about 1/1000 of a penny).

Sterling is in a somewhat larger range (~35 pips) as the market tries to make sense of the so-called time inconsistencies in the forward guidance from the Bank of England. While fully appreciating the shifting tone of Carney's comments, it is important to keep it in perspective. Despite media reaction, the fact is that the UK 2-year note yielded 66 bp at the end of May. It was around 90 bp after the Mansion House hawkishness and is now at 85 bp.

Sterling itself remains firm, though off the $1.7063 that Bloomberg said it reached on June 19. On the month, it is up 1.3%, making it the best of the majors, after the New Zealand dollar, which is backed by relatively high interest rates and a central bank that has already begun a tightening cycle. At the end of last week, sterling, we noted, was at the upper end of its Bollinger Band, and many new longs had been established.

The stretched market positioning left it vulnerable to the confusing signals from Carney, but the market's bullishness appears to remain intact at this juncture, with investors continuing to expect the UK to be the first of the G7 to hike rates. Given the likelihood of further declines in inflation in the coming months and the lack of any meaningful wage earnings growth, we thought the speculation of a Q4 14 rate hike was exaggerated. We continue to see the greater probability in Q1 15.

Surveys suggest some banks see a Q1 15 hike by the Federal Reserve, apparently taking seriously Yellen's poor attempt to give some temporal measure of "considerable period." We see Yellen having stepped back from that position, which was never a commitment, and that yesterday's comments by NY Fed President Dudley is the truer signal. A rate hike around the middle of next year seems most likely based on an information set that is very dynamic. We continue to see the first Fed hike in Q3 15as the most likely scenario.

Sterling's pullback from yesterday was extended marginally to almost $1.6950, where good bids were found. Today is the fourth consecutive session of lower highs, so to lift the tone and signal and end to this phase, sterling needs to rise through the $1.7030-35 area. On the downside, more bids may emerge near $1.6920.

The euro also extended its gains against sterling, reaching its best level since June 12. Given the trajectory of monetary policy, and the flash PMI reading warns that the regional economy is finishing Q2 with practically no momentum, the market is inclined to sell into euro bounces against sterling. The GBP0.8030-50 may offer an attractive selling opportunity on such views.

The euro remains confined to last Friday's trading ranges as it has the previous two sessions as well. The range so far this week is about $1.3575 to $1.3620. There is talk of large option expires today, mostly struck between $1.3600 and $1.3625.

The markets took little notice in the German and French confidence reports. Perhaps it was the stronger than expected Italian retail sales report that is the main news, as it were, and may be helping the Italian equity market buck the heavier tone today. Retail sales rose 0.4% in April. The consensus had expected a flat report after a 0.2% contraction in March. It is the largest monthly increase in nearly a year and the second positive reading since May 2013. The year-over-year rate rose to 2.6% (the consensus was for -0.5%), which is the first positive reading since last November and the largest since April 2011.

The dollar-yen is not going any place in a hurry either. A 5-tick range on either side of JPY101.95 captures most of the price action over the past three sessions. We note that since the euro convincingly broke below its 200-day moving average against the yen, it has been unable to resurface above it. It now comes in just above JPY139. With US 10-year yields back below 2.60% and equity markets trading seeing some profit-taking, it is hard for yen bears to be enthusiastic.

The price action is likely to pick up in the North American session, especially at the start of it. The US reports the third estimate of Q1 GDP. A sharp downward revision is widely expected. The contraction could be as much as 2% on an annualized basis. The large revision stems from an adjustment in household spending on medical care. While Q1 then was shockingly poor, investors already recognize the economy is bouncing back with growth estimated to be a little above 3% currently. We note that the Bloomberg consensus does not have quarterly GDP estimates below 3% though the Q3 2015 forecasting period.

This will likely be borne out by the other US data today, including the durable goods orders. Softer aircraft orders may conceal this on the headline, but it should be reflected in the details such as shipments and non-defense and ex-aircraft orders. Markit provides its preliminary estimate of its June services PMI, and when combined with the stronger than expected manufacturing PMI, will generate the composite figure.