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By Dean Popplewell

New dynamics are now entering the fray. Prior to this week, Capital Markets were beginning to buy into the next potential rate hike happening as early as Q4 from the BoE. A day and a couple of reports later, the market is focusing on the need for further stimulus to come from the ECB and BoJ. Sustainable volatility requires rate divergence and that is not just a tighter monetary policy. The potential for looser monetary conditions in the eurozone has all asset classes on tenterhooks - equities in the red, yields at record lows, gold prices rallying and a currency, contained by option barriers, trying desperately to underperform.

Prior to yesterday, investor positioning suggested (long GBP) that the BoE was to confirm the market's pricing of a November rate hike, but Governor Carney did not endorse. The BoE Quarterly Inflation Report was nowhere near as hawkish as expected, as it merely amended its spare capacity view lower and trimmed the wage growth forecast for this year and 2015. Governor Carney's comments contrasted sharply with the BoE's earlier more hawkish tone. Net result; pricing of the first rate hike was pushed from Q4 to Q1, 2015, sterling beaten and bloodied to a two-month low and the market to focus on the ECB.

Euro's giant economies flounder

Dismal economic growth numbers for both Germany (-0.2%, Q2) and France (-0.0%) earlier this morning is sending equity indices deeper into the red and pushing German 10-year bund yields to trade below +1%, a new record low. This is a sure sign that the market is anticipating further stimulative action from the ECB. The weakness of regional economic growth in Q2 only heightens concerns with the overall growth outlook at a time when a rise in geopolitical tensions is going to have a material effect to downside risks. Germany, the supposed backbone of Europe, economically struggling could force the ECB to act faster.

Even a breakdown of France's GDP shows no encouraging signs. A rebound in consumer spending only seems to be correcting the fall in Q1, and more importantly, capital investment has fallen again. Structurally, France is in poor shape. Political fragmentation is struggling to implement policies and the market should anticipate any future EU talks to get tenser. For Germany, the weak GDP report could be attributed to some production being shifted to earlier months; nevertheless, for the supposed power horse of Europe, any material weakness has "knock-on" consequences throughout the region.

Eurozone data is either on balance or worsening, which would suggest that it could be the makings of a more prolonged downturn rather than a dip. A sustainable squeeze in growth in Europe or Asia could very much influence the Fed's own timing of higher rates. Expect the market to be paying close attention to Fed Chair Yellen's speech for hawkish tones at the Jackson Hole Economic Symposium in a few weeks. Dealers and investors need to get a sense of the Fed's current thought process.

What will the ECB do?

Collectively, the eurozone Q2 GDP (+0.0% vs. -0.2%) and final July HCIP (+0.4% vs. +0.4%) this morning was less negative - wider downside misses were expected. The ECB has been adamant that they need to look at the first of the TLTROs, to be delivered next month to gauge whether they will be required to deliver further easing. Draghi will maintain that they euro policy makers do not need to be proactive, but rather take their time and assess the impact of June's easing package. The market could be looking at Q1, 2015 before any action from the ECB. Until then, investors and the market will be focusing and pining on whether euro growth/inflation worsens.

What of the dollar?

The 18-member single currency (€1.3375) has, so far, come out of this morning's eurozone's data rush somewhat intact. This would suggest that the market was probably positioned for more downbeat reporting - the weaker "short" EUR positions have been squeezed. Overall, the USD is expected to maintain broad support against the other major currency pairs with the greenback aided by divergence in growth, policy and yields. Even the dollar's supportive carry-with-yield differentials are moving in favor of mighty buck - in other words the USD is converting from a "funding" into an "asset" currency. Thus far, the EUR/USD continues to hold above its 2014 low of €1.333 with dealers noting option barrier defense at €1.3325 and €1.3300. Despite large "short" EUR positions leaving the topside vulnerable, the overall view remains bearish for the single-unit with range trading still preferred until the option barriers come off. It's only a matter of time before the year's EUR outright low will be taken out.

Japan: not left in the dark

Overnight data shows that Japan machine orders missed consensus (+8.8% vs. +15.9%) resulting in renewed stimulus talks. Earlier this week Japan was able to shrug the largely anticipated contraction in Q2 GDP, but the reaction to a miss in June machine orders figures and the government downgrade of the sector has had more of an effect. It has managed to push USD/JPY higher (¥102.45) with the market starting to believe that a consistent shortfall in leading indicators certainly brings a more proactive BoJ back onto the scene.

Forex heatmap

Source: Short EUR Positions Need Patience