The dollar strengthened to highs around 1.3415 in early Europe on Wednesday, but was unable to sustain the gains and weakened sharply to lows around 1.35. The dollar stabilised close to 1.3460 in choppy trading as markets tested technical levels.
The Euro-zone data was stronger than expected with a 2.7% monthly increase in industrial orders for an 8.0% annual increase which will ease any immediate fears that Euro strength is damaging the manufacturing sector.
There were no major US economic developments during the day, but the data releases over the next two days will be significant. Jobless claims and durable goods orders on Thursday will be monitored for evidence on industrial growth and the labour market.
The housing data will be a key influence with new and existing home sales data due this week. A significant monthly increase in sales would help reinforce increased optimism over the US economy and maintain the more favourable yield spreads seen over the past week while sharp declines would undermine confidence. Overall, the dollar will be in a better position to renew gains against the Euro if the yield spread on 10-year Treasuries over bunds rises to above 50 basis points from just below this level at present.
The yen remained on the defensive in local trading on Wednesday, weakening to 3-month lows against the dollar at around 121.80. The yen regained some ground against the US currency in Europe, but was unable to make significant progress.
Global stock markets have retained a firm tone over the past 24 hours which has continued to encourage carry trades with further speculation over capital outflows from Japan as investors seek higher yields. The Bank of Japan has maintained a cautiously optimistic stance on the ending of deflation and is likely to increase interest rates again earlier than expected. A firm policy will eventually underpin the yen, but markets will not take major notice of the Bank of Japan stance unless global risk aversion increases strongly.
Sterling found support close to 1.97 against the dollar on Wednesday and gained strongly to highs near 1.99 before settling close to 1.9860. The UK currency also extended the recent recovery against the Euro to 0.6775.
The Bank of England voted 9-0 for a 0.25% interest rate increase in May according to the latest minutes. The bank stated that further rate increases could well be required in future months. The bank did discuss the possibility of a 0.5% rate rise at the meeting, but some members were cautious over the growth outlook while the bank considered that inflation expectations had been generally contained.
The minutes will maintain expectations of a further rate increase on a 3-month view with some speculation over another increase in June, especially if near-term data suggests that inflationary pressure is not subsiding.
Sterling will continue to gain underlying support from short-term interest in carry trades and yen weakness. Underlying investment-orientated capital flows are still liable to be less favourable for the UK currency which will increase the threat of a sharp drop in Sterling if there is a reversal in carry trades.
The Swiss currency strengthened to near 1.65 against the Euro in early Europe on Wednesday, but failed to extend the gains and settled close to 1.6530. The franc strengthened to highs around 1.2240 against the dollar as the US currency dipped sharply before a retreat to 1.2270.
There have been a flurry of warning comments from National Bank members over the inflation risks posed by franc depreciation. There is likely to be further speculation over a 0.5% increase in interest rates at the June council meeting. The National Bank protests and speculation over a 0.5% increase will discourage short-term franc selling.
The Australian dollar found support below the 0.82 level in local trading on Wednesday and strengthened to highs around 0.8255 as the US currency retreated.
The domestic influences remained limited, although there was a firm reading for leading indicators which continues to suggest a robust GDP expansion. The Australian currency will gain support from speculation that interest rates could still be increased. At this stage, the currency will be held back by a narrowing of yield spreads as confidence in the US dollar improves while the Australian dollar will also be vulnerable if metals prices continue to fall.