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Warum? Schaut auf den Chart weiter unten und vergleicht das Muster mit denen, in den Monaten vorher... Das sieht aus wie die Ruhe vor dem Sturm und der Sturm duerfte heute losgegangen sein! Euro’s Chance to Accumulate Gains by Ashraf Laidi
The broad retreat in the US dollar of the past week has passed quietly mainly due to the lack of fundamental catalysts. The only 2 pieces of news were the Treasury data on capital flows; showing record high purchases of US bonds along with record high sales of US stock, and a mixed report on manufacturing from the Philadelphia district Fed showing a sharp decline in activity (8-month lows) coupled with soaring prices (16-year high). The dollar ended the week lower for the first time in 6 and 5 weeks against the yen and the Aussie respectively.
While so much talk has revolved over rising US interest rates, prospects of an ECB tightening have drawn very little attention. In the January 11 piece “Greenspan's Nonchalance vs. Trichet's Cautiousness”, we argued that the ECB’s next interest rate move would be up rather than down arguing on the main premise that an ECB rate cut would have to be reversed sooner than later due to incipient inflationary pressures. We also postulated that intervention--verbal and operating--would be more effective in stemming euro strength than an actual rate cut. The ECB’s threats to intervene did prove successful and indeed brought the currency lower.
The other catalysts to the euro’s decline were increased calls of ECB rate cuts by concerned European leaders, record high foreign purchases of US assets suggesting a sustainable financing of the US trade gap, and speculators’ scaling down of long euro positions against the dollar. Last but not least were improving labor US data and emerging signs of inflation, all of which raised chances of a summer Fed rate hike.
Today, chances of a Fed June hike stand more than 90%, appropriately fitting the definition of “priced in the market”. Such discounting has effectively helped a relative flattening of the yield curve via its greater impact on lifting the short-end of the curve than on the long end. Since the May 6 FOMC meeting, 2-year yields rose more than 6% to today’s 2.54% while 10-year yields edged up a mere 2.4% to today’s 4.74%, helping to explain the general retreat in the dollar.
But there are other developments encompassing the EURUSD rate, which go beyond US monetary policy. These include emerging inflationary pressures in the Eurozone, renewed speculative futures interest in the euro, soaring net sales of US equities by foreign investors and increased perception of a modest tightening by the Fed.
Inflation, Futures and Inflows
After briefly falling to an unprecedented 1.6% in February, Eurozone inflation is back on the rise. Consumer prices rose 2.0% in the year ending in April from 1.7% in March, nearing the ECB’ inflation target. Interestingly, the bulk of the rise was made up by alcohol & tobacco products, housing and health items, all of which are items making up the core of consumer prices. Meanwhile, the oft-blamed energy and food prices rose only modestly. In fact, when excluding both of these items, CPI rose 2.1%, higher than the headline figure. Thus, as in the US, the Eurozone is exhibiting broad-based increases in pricing power. But unlike the Fed, the ECB is mandated to contain inflation at a rate close to 2.0%. These forces suggest that ECB watchers should start watching for ensuing hawkishness from Trichet et al, which could start tempering rate-hike excitement in the US dollar.
On the speculative front, traders’ commitment reports show that net long futures positions rose by an average of 37% in the last 3 weeks, helping to explain the bounce in the currency from its multi-month lows of $1.1750-70. Last week, net long positions in the euro pushed reached 13,422 contracts, attaining their highest level since the last week of February. With the Fed June hike nearly perfectly discounted in the market, the US trade gap making noise again, speculators could be encouraged to extend their interest towards the 15,000-20,000 contracts level.
Last but not least are resurfacing worries with the swelling US trade gap. When the deficit hit an all time high two weeks ago, we warned that "a continued sell-off in US equities and fixed income markets could thwart” the record breaking foreign inflows and jeopardize the financing of the US deficit. Indeed, a week later, foreigners were reported to have sold a record net $13.5 billion worth of US stocks in March, while foreign central banks bought more than half of US treasuries. We stick by our warning that the April equity numbers will show further deterioration, while the fixed income figures may not receive the same preferential treatment from foreigners. This is not only due to the 6% decline in the long bond during the month, but also due to the slowdown in Treasuries and Agencies held in custody for foreign official accounts at the Fed. Such signs of cooling foreign interest in US assets, coupled with the escalating trade deficit, make way for a non-appetizing dollar recipe.
This week
This week, the euro faces what seems to be an ominous upward revision in Q2 GDP from 4.2% to 4.5-4.7%. But markets may show indifference to such a revision, which is largely driven by an expected build up in inventory, courtesy of a threatening build-up of inventory build-up in the auto industry. Barring this artificially positive development in GDP calculation, the overall figure would be revised down due to the 4.6% rise in March imports relative to the 2.6% rise in exports.
On the inflation front, the price deflator is likely to show a non-revised 2.5% rise. But the more important inflation figure is Friday’s release of the April core PCE price index, expected to rise as much as 1.7% y/y, after hitting a 12-month high of 1.4% in March. With a Fed hike already priced in, new inflationary evidence should be a negative for the dollar.
Further dollar declines could ensue on Friday, when the Chicago PMI could join the latest string of diffusion indices reports (ISM, NY ISM, Philly Fed) showing slowing activity along with rising price pressures.
Now that the single currency has risen above its 2-year trend line support around the $1.1750 figure, the next obstacle arises at the $1.2065-70 target, which is the trend line resistance from the all time high. The combination of emerging US inflation and a retreat in business activity could extend euro gains towards the $1.21745 target, the trend line resistance from the all time high. This would chart a clear break of the 200-day moving average, and give the currency a rare 2-week gain, not seen in 3 months. Given the improving euro landscape, any declines below $1.19 should be supported at 1.1825-30.
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