Despite rising pressure on the European Central Bank (ECB) and President Mario Draghi to react to the euro’s continuing climb against the greenback and persistently low inflation, investors should expect little more than talk from the central bank at its policy rate-setting meeting today.
Most analysts believe the ECB will hold steady on interest rates and simply repeat its concerns about a strengthening EUR’s impact on the eurozone’s stubbornly low inflation. Though the 18-member single currency is inching toward the €1.4000 level, few expect the ECB to act unless it hits €1.42.
Meanwhile, part of the forex short-term market’s deadlock conundrum was answered yesterday during Federal Reserve Chair Janet Yellen's congressional testimony on Capitol Hill. Also comforting capital markets is the glimmer of hope that the Ukraine crisis could ease after Russian President Vladimir Putin said that he was pulling troops away from their border.
Also this morning, the market gets to consider the outcome of more gentlemanly inaction courtesy of the Bank of England’s (BoE) rate-decision meeting. Though the BoE opted to keep its interest rates at a record low 0.5%, a strengthening British economy and a booming housing market will surely spur hawkish sentiment among the Monetary Policy Committee’s members.
After a brief choppy period during the Fed chair’s testimony, the market settled down with the mighty dollar ending the day little changed across the Group of 10 board. Yellen possibly was a tad more dovish with the rates lower-for-longer sentiment remaining firmly in place. Equities stateside rode the waves and took the news well with the Dow and S&P adding +0.7% and +0.6%, respectively.
The risk-on mentality has so far followed through overnight, egged on by a surprisingly strong Aussie employment report (+14.2k jobs and +5.8% unemployed), and above expectations Chinese trade data ($18.5B). The Aussie dollar climbed to a fresh three-week high ($0.9386) while its neighbor, the Kiwi dollar, continues to trade nervously from threats by Governor Graeme Wheeler of possible Reserve Bank of New Zealand intervention ($0.8665). For now, investors are riding the risk wave, forgoing and paring back safe-haven trades and looking for yield, mostly with the carry trade. With most things good there tends to be a disclaimer and that comes in the shape of uncertainties with China trade data over the next few months. Analysts warn that contracts signed at the Cantonese trade show (China's largest) dropped significantly -- down -12.5% in orders from major partners. The next few months are expected to reflect more accurately the trade situation in the world's second-largest economy.
The dollar’s demise has been blamed on low yields, sovereigns rebalancing, and safe-haven trades. However, there is a possibility that the dollar bears may be getting too far ahead of themselves. Low volatility is not necessarily symptomatic of an evolving downtrend. There is no denying that some dollar dislikes are being influenced by the EUR hovering precariously close to that psychological €1.4000 level. Some buy U.S. yields, from mid-long, trading at the lower end of this year’s range (2.63% and 3.41%), and others buy the only carry trades that seem to be working: those that are USD funded. For many, the dollar was supposed to be the "go-to" trade for this year, however, the lower-for-longer mantra and the lack of inflation pressure has caused many to reverse their long dollar positions. A large percentage of those speculators now sit relatively short. With the DXY sitting near 79, what's the risk-reward of easing into long dollar contrarian positions, especially with the ECB about to be called to task as the 18-member single currency approaches supposedly verboten territory?
The EUR was a sideshow yesterday, as the market awaits the ECB's rate decision and in particular Draghi's press conference. Euro inflation remains well below the ECB’s target level, pulled lower in part by the stronger EUR. However, coupled with stronger periphery data this week, it suggests a broader economic recovery remains in play. The market consensus is that the ECB will take no action this week and instead will wait for the June meeting, which the fixed-income class is pricing in. If Draghi fails to dent the EUR with dovish rhetoric the €1.4000 barriers could quickly fall. Options traders did see a pickup in demand for €1.4000 strikes this week. Depending on the weak short positions, EUR pain threshold stop-losses strategically placed above €1.4050 could be rather attractive. Today's press conference should indicate how determined the ECB is to keeping a lid on the EUR – a failure to convince could possibly establish another couple of cents on the topside.
In the case of the BoE, Carney and company will be closely watched in light of U.K. unemployment breaching the 7% unemployment threshold to 6.9%. The BoE was expected to leave the bank rate at +0.5% and it did not disappoint on that score. What of the pound? The probability of cable trading through its £1.7000 level certainly increases if Draghi fails to stop the EUR trading through €1.4000. However, the lack of clear singles between here and the 2009 peak of £1.7045 has many sitting somewhat neutral. If GBP happens to close above £1.7050, it would trigger another bullish signal opening up the possibility of a £1.7300 handle print.
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