Submitted by Shant Movsesian and Rajan Dhall MSTA from fxdailyterminal.com
Over the past year or so, we have seen the EUR gaining from strength to strength, pushing hard against the USD which in the current climate seems to be getting little reprieve from the political backdrop required to instill confidence in any currency.
As we saw on Friday, the fallout in equities saw a rush for the safe havens, of which the USD has clearly fallen out of favour, and replaced a while back by the EUR, which is also benefits when risk appetite is healthier amid the constant reminder of the the robust recovery in the Euro zone. The latter forms the basis on which many believe the ECB are falling behind the curve, but with inflation lagging – and this partly down to persistent surges in the EUR – the governing council have clearly been reluctant to call the end of QE for fear of another overreaction, which has taken hold of the JPY as the market calls, or rather pre-empts BoJ normalisation down the line.
These ‘pro-active’ moves have been excessive in nature in more recent times, just as we saw with the BoC hikes prompting sharp gains on the rates curve as well as the CAD, but which have been sharply reversed, albeit with the overhang of NAFTA uncertainty which has been prevalent over this time. With the EUR, it is the exchange rate which has been running away with it, less so rates as safe haven demand keeps short date German paper (in particular) bid to keep rates negative out to 5yr. Spreads with the periphery are the focal point as a result, and have narrowed to some degree though naturally we saw Italian BTPs come under pressure during the elections. This only resulted in a minor dip in the single currency, with long exposure still relatively high despite the spot rate clearly looking overstretched above the 1.2500 mark.
As ECB policy is inevitably on the turn, we once again expect economic divergence to start showing the strains on the level at which the various member states expect monetary policy to be. It is no surprise to see the German contingent leading the calls for the ECB to call time on the APP, but even the Buba’s Weidmann has conceded that rates will only rise well past the date bond buying cessation. Given this to be the case, we struggle to see what this insistence on forward guidance at this stage will do (rather than actually implementing it), given German business sentiment is starting to show concerns over the level of the exchange rate, and more so now when trade tensions are reaching fever pitch.
Rather than join the chorus looking for a EUR/USD move up to 1.3000 this year, which is in part predicated on further USD weakness, we continue to see a move back down to 1.2000 at some stage, but this does not rule out another stab at 1.2500, perhaps the 1.2600 level where we can only see exhaustion setting in again. If we do test higher levels first, this will then be the fourth (or fifth) time we have stalled at higher levels, the last episode falling shorting in the mid 1.2400’s. We highlight this pair due to the continued exposure levels as well as the overcrowded USD shorts in the market, which are also vulnerable to activity in the equity markets, based on a potential follow through into emerging markets and a (USD) squeeze as a result.
Looking to some of the other currency pairings, EUR/JPY has come some way south of the highs seen closer to 137.00-138.00 this year, but on the daily charts has a lot of room on the downside before we reach value levels highlighted in the 115.00-110.00 area. In contrast, USD/JPY failed to test the 114.00-115.00 area before heading south, and has clawed its way through 105.00, but with limited momentum given the lack of breathing space north of 107.00. These are key technical factors which are worth considering, as we can no longer ignore the developments in the stock market, which are not only down to fears of a trade war, but of a Federal Reserve maintaining their gradual approach to rate normalisation. The ECB would have perhaps been hoping for a more hawkish ‘delivery’, but will have to delay the inevitable in the hope that the market finally takes note of interest rate differentials, which have been roundly cold-shouldered in this era of trading off expectations even further out on the horizon.
As an aside, we saw the USD reaction to last week’s rate hike as borderline bizarre, and if anything, more constructive for the greenback given an immediate move to 4 hikes this year would have flattened the Treasury curve. It didn’t.
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