Ebury: Latin American currencies join US dollar in strong rebound as stocks correct

Last week we saw an unusual combination of winners. The US dollar bounced back, perhaps unsurprisingly given the stretched short dollar positioning in markets, yet another positive surprise from the US labor market, and the general correction of recent trends in financial markets. Unusually however, key Latin American currencies managed to buck the usual correlations and actually rose against the greenback, as the Brazilian real and the Mexican peso both finished at the top of the weekly performance rankings. Signs that the pandemic may be peaking in both those countries deserve some of the credit, undoubtedly, but also the fact that both those currencies had suffered the worst pandemic losses of all the majors and were undoubtedly cheap.

The key for next week trading will be the ECB September meeting on Thursday [link to the special report?]. Markets will be eager to see the central bank's reaction to the latest economic numbers, specially the inflation shocker that saw core inflation drop to an all time low of 0.4% year on year. We think that the combination of Euro inflation weakness, US labor market strength and extreme long Euro positioning is likely to result in temporary weakness in the common currency.

GBP
Sterling seems to be caught between two opposing trends. On the one hand, economic data in the UK has been surprising to the upside. On the other, there seems to be no progress in the Brexit negotiations so far. Our expectation is for economic data to start taking a back seat to Brexit negotiations over the next few weeks. Given how fast the Pound has risen since the pandemic lows and the tendency to take Brexit negotiations down to the wire, this could mean recent short-term weakness in Sterling continues.

EUR
Alarms must have gone off at the ECB's Frankfurt headquarters last week. A shocking inflation report showed the key core vastly under expectations at 0.4%, its lowest point ever. Then the Euro breached at one point the psychological level of 1.20 dollars, though it fell back later in the week. We'd wager neither development had been expected by the ECB at its previous meeting. While we do not expect any immediate change in monetary policy, this week's meeting takes on added importance for FX traders. It will be key to see how much tolerance there is in Frankfurt for further currency appreciation in the context of near zero inflation.

USD
US economic data was fairly strong last week. The ISM indices of business activity are all in solidly expansionary territory, above 56 for both services and manufacturing. Critically, the labor market report for August confirmed the positive news from the weekly jobless numbers. A net 14 million jobs were recovered in August. Even more positive was the household report on unemployment, pegging the unemployment rate at 8.4%, far below expectations.

This week, with little in the way of news beyond Friday's inflation numbers, we expect the dollar to react primarily to news from the ECB meeting as well as any headlines from the negotiations  between Democrats and Republicans on the size and composition of additional stimulus measures.