Euro Pojected to Rebound Versus Dollar After Slip, Longer-term Trend Seen as Up
The Euro to Dollar exchange rate (EUR/USD) has had a rough start on Tuesday morning after losing almost a third of a percent during the overnight trade.
The pair has fallen from Monday’s close of 1.1165 to lows of 1.1110 overnight – a fall of over half a cent to the Dollar.
Since then there has been a relief rally up to the 1.1140s.
Looked at on a longer-time frame the recent sell-off appears as nothing more than a correction in a longer-term uptrend which could resume at any time.
Draghi Playing It Safe
The reason the Euro weakened on Monday and into Tuesday was that the head of the European Central Bank (ECB) Mario Draghi poured cold water on hopes the ECB would normalize their extraordinary monetary policy measures as a result of improvements in the Eurozone economy.
These measures - intended to stimulate the Eurozone's economy - have kept interest rates in the region at record lows barely above 0.0% while vast sums of money have been printed to buy up Government and corporate bonds.
Interest rates are a key driver of currency strength – the higher the better – so the record low rates in the Eurozone explain why the Euro has traded at such low levels.
Draghi appeared before the European Parliament’s Economic and Monetary Affairs committee for his second appearance of the year before European lawmakers in his role as Chair of the European Systemic Risk Board.
Draghi’s insistence that more stimulus was required suggested they will remain low for longer, something that would disappoint those who have been buying the Euro in anticipation of a noted shift of policy.
However, not all strategists took his comments on face value.
“You could easily be lulled into thinking that Mario Draghi wants to keep a lid on the Euro ahead of any decision to further slow the pace of ECB bond-buying. A quiet Monday with US and UK markets closed and Mario Draghi took the opportunity to warn that the Eurozone still needs an extraordinary amount of monetary support,” said Société Générale’s Kit Juckes, raising the possibility at least, that Draghi was manipulating the Euro down.
But, that was not the only reason for this morning’s sell-off: the strategist also highlighted the saturated bullish futures positions on the Euro – otherwise known as the Commitment of Traders Report or CFTC.
CFTC is released every Friday and shows the number of futures contracts held by large traders – hedge funds etc - on the Chicago Futures Exchange.
Why is it relevant? It is relevant because when positions get overweight in either direction, the imbalance is a sign of a heightened risk the market will start to readjust in the opposite direction.
So, if CFTC’s show a record high number of speculators hold ‘long’ futures contracts and are therefore bullish it can be a sign the market is about to turn around and go lower – counterintuitively. The same goes for short contracts.
The once-thought-slain dragon of political risk in the Eurozone has also possibly been resurrected, and could now start to be a menace to the single currency too.
“Throw in the growing possibility of earlier Italian elections (this autumn), and the CFTC data that came out Friday evening showing a further jump in net speculative Euro longs, and the stage may be set for a bit of a shake-out,” Said Juckes.
Dollar Not Stronger For Longer
The ‘shake-out’ currently pulling EUR/USD lower could actually be a golden opportunity to buy more Euro’s.
“We wouldn't see a shake-out as anything other than a chance to buy Euros at better levels, against yen, pound or dollar, however. Firstly because the improving European economic backdrop will underpin it and secondly because the dollar is lacking support,” said Juckes.
Although the Dollar appears to be rising versus the Euro now, it is not expected to sustain upside.
The US 10-year Treasury Note reflects interest rate expectations in the US and futures contract positioning is at an overbought extreme according to CFTC data.
10-year Notes risk selling off which would be indicative of lower interest rate expectations, which would have a knock-on effect of weakening the Dollar.
Eurozone inflation data out on Wednesday Morning is likely to have an impact on the pair, but the consensus appears to be that the inflation rate will remain subdued, weighing on the Euro, if anything.
Yet today’s PCE inflation data, which the Federal Reserve takes very seriously, is also likely to show a contraction from 1.6% to 1.5% putting pressure on the Dollar as well.
“The DXY has fallen further, faster than is justified by the modest pull-back in US yields, and indeed, the CFTC data also show a rapid build-up of long 10-year Note positions. But along with German inflation and Eurozone confidence data today, we get US personal income and consumption figures, including core PCE inflation, which is likely to have slowed to 1.5% from 1.6%. I can't see that as a catalyst for turning the trend in treasury yields back upwards,” concluded Juckes.
