A Shot Across the Bow for the EUR Bull

  • Draghi’s crying call supports QE trades
  • Euro session looking To re-establish EUR shorts
  • Bund and Treasury yields capped for now
  • Traders zero in on commodity currencies’ performance

George Soros’s Quantum fund did take on the Bank of England and broke it on what is known as Black Wednesday in 1992, but in general, investors should be wary of taking on a central bank. Historically, they have more ammo than the market.

Yesterday, European Central Bank (ECB) President Mario Draghi slowly put his foot on the brakes, temporarily capping the EUR’s May rise by reiterating that the ECB’s vast stimulus efforts will remain in place “as long as needed.” Or at least until ECB officials are confident that they will meet inflation objectives on a sustained basis.

Lately, both dealers and investors have bet the recent string of moderately upbeat European data will prompt the ECB to pull the plug on its quantitative easing program before September 2016. The ECB targets annual inflation near +2%, and the reality is that consumer prices were flat in the eurozone last month on an annual basis, and have been negative for several months before that. So there is no hurry.

What’s important is that the monetary efforts are sustainable, growth is sustainable, and with that, sustained inflation. To get to these continuous levels requires the ECB to maintain a lower finance cost for investors and a lower cost of borrowing for consumers. The recent sovereign bond rout that has led to ballooning yields only hampers the ECB’s efforts.

Forex Relies on Bund Yields

There are tentative signs that the recent rout in bonds is easing and that the strong correlation between yields and the EUR’s direction remains intact. All week technical analysts have been trying to keep up with some of the extreme moves across the currency pairs, plotting next resistance levels as the “long” dollar squeeze prevailed. Now it seems that Europe is happy to contemplate as to where to short the EUR, believing the divergence between the ECB and the Federal Reserve would likely rise again. This should allow quantitative easing-based (QE) trades to find firmer footing especially after Draghi’s comments yesterday. Already the German 10-year bund yield is lower by over -7 basis points to test below +0.64%, which is allowing the EUR bear to close out the week leaning on the single currency.

It seems that short covering from day trading types and short-term model driven accounts is helping push the bid in bunds as futures lead the price action. Europe is simply trying to catch up to the rallies in Treasurys and Japanese government bonds seen yesterday.

Nevertheless, Draghi’s QE crying call is being used to change mid-bond traders’ mindset. They are naturally flattening (-2.5 basis points to 81 basis points since yesterday) the belly of the bund curve (2s and 10s), a sure sign to some that rate divergence is very much in play again. Individually, 10-year bunds are capped by +0.80% at the moment but remain a danger, while 10-year Treasurys managed a decent recovery from +2.365% high point this week (last at +2.19%). However, be aware that a lack of liquidity in the fixed-income market remains an issue and could exaggerate some of the moves as some traders take an extended holiday weekend.

Markets Eye Commodity Currencies for a Flutter

Investors are finally willing to look more closely at commodity- and interest rate-sensitive currencies like the Aussie, Kiwi, and Canadian dollars. Of late, they have been outperforming the “mighty” dollar by some degree: the loonie is trading C$1.1930, the Aussie has breached A$0.8140, and the Kiwi dollar is printing $0.7550. These levels are in direct conflict to their respective central banks’ rhetoric. The recent strength by commodity currencies is showing signs of reversing, with topping chart patterns in AUD and NZD outright, while USD/CAD shows signs of basing.

As he is wont to do, Reserve Bank of Australia Governor Glenn Stevens has been taking every opportunity to talk down his currency. This week’s federal budget Down Under was more a political rather than economic showing, and it allowed the Aussie to find firmer footing. Also aiding the AUD’s push to new heights was Fitch Ratings stating that there was little evidence to suggest Australia’s AAA sovereign rating would come under threat. Nevertheless, China (Australia’s largest trading partner) will be the AUD’s undoing in the medium- to long-term as soft data continues to challenge China’s desired +7% growth rate.

The CAD’s meteoric rise has been supported by the stabilizing prices in oil. Since the middle of April, crude prices are up +45% from their one-year lows. But with +60% of that rise due to a reduction in production and not growth expectations (global first-quarter growth is projected to be +1.2%, the lowest in 25 years), it will eventually hinder the CAD’s progress. The demise of the USD has clearly helped push energy prices higher, and there are tentative signs that the dollar’s rout has been stretched enough. CAD bears remain better buyers of USDs on dips, as they look for some relief toward C$1.2250.

The NZD, meanwhile, has been rather active all week and has taken another small hit in overnight trading after dairy giant Fonterra Co-operative, which sets the world’s dairy prices, announced an unexpected cut in its production volume forecast. With fixed-income traders pricing in a -50 basis point for the Reserve Bank of New Zealand to cut its official cash rate by year-end, it has dented most bulls’ bias for a stronger NZD. Through NZD$0.7360, the bears will be looking to target the 2015 low of NZD$0.7175.

Forex heatmap

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell