The dollar pared gains after global equities rebounded lessening the earlier session’s safe haven demand . There were renewed fears about the health of the US recovery as services PMI posted a below expectations result coming in at 53.8 rather than the expected 55. This has increased fears that the US economic recovery may be stuttering to a halt. The question now is whether these lacklustre results are a sign that a deflationary trend is beginning? If so in the longer term it may increase the value of the dollar as deflation may increase demand for treasury bills. The greenback ended the session down to 1.2625 against the euro and down slightly to 1.5148 against sterling.

   The euro rose yesterday as demand for riskier assets returned, however the longer term the outlook for the euro is flatter. The stimulus for the present rally may be evaporating with the unwinding of carry trades. Slightly longer term much depends on the results of the European banking stress tests which are expected to be published on 23rd of June. The tests will lay bare details of their capital holdings including the sovereign debt exposure of over a 100 of Europe’s largest banks. Up until then it is though the market will remain broadly flat. On Tuesday the euro climbed to 1.2525 against the dollar and was up to 110.49 against the yen.

   The pound lost ground after the release of figures which showed shop prices falling and reinforced the static interest rate outlook. Much of the recent rally was built on the premises that interest rates would rise in the UK which has some of the lowest in the world but this hawkish outlook is losing support. It seems more likely the UK will enter a period of stagnant growth as the austerity cuts decrease spending and the need for continued monetary flexibility continues. The pound, therefore, may drop in the short term. If there is a double dip recession then the pound is thought to be one of the international currencies which will be worst hit. In addition central bank holdings of other non-major currencies including Norwegian Kronor may supplant demand for sterling, as some of these less prominent currencies have stronger fundamentals backing their value. At the end of Tuesday’s trading the pound fell to 1.5148 against the dollar and 132.57 against the yen.

   The yen was mainly up against most currencies as Asian equity markets slid amidst fears about the fragility of the global economic recovery and investors sought safe havens again. The yen rose to 87.52 against the dollar and 132.57 against the pound. As equities continue their retreat the yen should benefit and increase in value. Given the relative resilience of Japanese exports even in the face of a stronger yen this trend may continue until currencies such as the euro reach levels where the disparity really starts to make a difference to Japan but right now the risk aversion - benefit relationship with the yen appears to be intact.

Analysis prepared by:

Joaquin Monfort
Forex4you analyst