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There has been a dominant theme in the foreign exchange market that had seemed to waver in recent days, but has returned in force today. That theme is about the divergent performance of the dollar, which makes it difficult to discuss the greenback in general. Essentially, that theme is for the euro and sterling to outperform the yen and dollar-bloc.

Today, sterling has made new highs since 2011 and the euro is up a cent and posting its largest advance in nearly three months. The euro is back above the 100-day moving average. Pullbacks to that average have been bought since last July and that buy-on-dips strategy appears to still be in vogue. A move now above $1.3655, immediate resistance, can spur gains to $1.3700 and then $1.3750.

Sterling has been bolstered by the hawkish read of the BOE minutes and the larger-than-expected drop in the unemployment rate. The market has been warned by BOE officials that additional forward guidance will be delivered when the unemployment rate reaches the 7.0% threshold. Officials have been at pains to indicate that a rate hike is still some way off, but market participants are somewhat less sanguine. The implied yield on the December 2014 short sterling futures contract has risen 14 bp since last Friday as the market brings forward rate hike expectations.

A sterling move above $1.6620 would signal a test on $1.6750, but longer-term there is potential toward $1.70. Initially, the soft CBI distributed trends survey is consistent with ideas that recent retail sales report was too good to be true. Support is seen near $1.6550. Sterling is paring some of its gains against the euro today after seeing its best level in a year yesterday. However, new euro selling is likely near GBP0.8320-40.

The euro has been lifted by the flash PMI readings. The euro area manufacturing PMI rose to 53.9 from 52.7 in December. This is the best reading since May 2011. The service PMI rose to 51.9 from 51.0, which is a 4-month high. The composite rose to 53.2 from 52.1 and is the sixth month above the 50 boom/bust level. Of note, strong gains were seen in new business. The flash report includes only Germany and France. Given the general recovery in the periphery, the risk is on the upside for the final report.

German manufacturing goes from strength to strength. The 56.3 reading compares with 54.3 in December. The service PMI was unchanged at a firm 53.5. New business, exports and output were particularly strong.

France, the laggard in the region, provided pleasant surprises. Even though both PMI readings remain below 50, the pace of contraction eased. Manufacturing rose to 48.8 from 47.0 in December, while services rose to 48.6 from 47.8. The composite of 48.5 represents a 3-month high.

Meanwhile, news of a disappointing HSBC flash manufacturing PMI for China gave the bears another reason to sell the fragile dollar-bloc currencies. The flash reading of 49.6 (from 50.5) was the first contraction in six months. New export orders were poor, according to the preliminary report. The final reading is due next week. The official survey is expected Feb 1.

There is much focus in China on the month-end maturity of wealth management products. While offering high yields (e.g. ~10%), the products have also been perceived to be protected by the banks distributing them. This creates a moral hazard that Chinese officials are sensitive to. Previously, reports suggest that China's largest bank may not make good on investors of a particularly troubled trust. This sparked concerns of knock-on effects. However, today a report suggests that ICBC and the China Credit Trust may each assume responsibility for a quarter of the payment (CNY3 bln or ~$500 mln) trust.

Following the Bank of Canada's dovish statement yesterday, the market hardly needed a new reason to extend the Canadian dollar's losses. The US dollar advanced to almost CAD1.1175, nearly a big figure higher than yesterday's North American close. Although the market is stretched and short positions in the futures market were already at record levels as of early last week, the shorts feel no pain and have momentum at their backs. The next technical objective is near CAD1.1235, which is 50% of the US dollar drop from the last 2008 high.

Helped by the higher-than-expected Q4 CPI figures, the Australian dollar had rallied to almost $0.8890 yesterday, but had already run out of steam ahead of the European session yesterday, while the disappointing Chinese PMI encourage the Aussie bears to jump back in. The retreat in the Aussie saw it return toward the multi-year lows seen on Monday just below $0.8760. It stabilized in the European morning, but looks set to struggle to resurface above $0.8820.

The dollar rose to its best level against the yen (~JPY104.85) since January 10, but remains range-bound, frustrating bulls and bears alike. The greenback tested support in Europe near JPY104.20 and appears poised to recover in the North American session. Of note, Japan's 20-year bond sale drew record demand. The JPY1.2 trillion sales drew a bid-cover of more than 5.3 times. The strong interest pushed the 20-year yield down 4 bp and helped ease the 10-year yield as well.

The US reports weekly initial jobless claims, Markit's preliminary PMI, existing home sales and leading economic indicators. The reports may pose some headline risk, but are unlikely to change the underlying expectation for Fed tapering to continue next week. Canada reports November retail sales, which given the more recent developments, are unlikely to provide new trading incentives.

Source: Back To The Future: Euro, Sterling Bid, Dollar-Bloc Heavy