EUR Bears Put the Boot In

Last month’s Bund rout that caused yields to spike and Treasury-Bund spreads to tighten supported the EUR. Any comments that would flatten the Bund yield curve would have an immediate negative impact on the common currency. Last week, European Central Bank (ECB) President Mario Draghi fired the first warning shot across the EUR bulls’ bow, temporarily capping the single currency’s rise by reiterating that the ECB’s vast stimulus efforts will remain in place for “as long as needed.” Today, two other members have managed to deliver the euro a massive blow with more dovish comments concerning the recent reversal in bond prices and inflation expectations.

Another ECB Warning Shot

Earlier this morning, ECB Executive Board member Benoit Coeure delivered another hammer blow that has the EUR bull in full retreat. Despite the weakness in bond yields, he said the central bank would moderately front-load its quantitative easing (QE) purchases because of low market liquidity in the summer. In effect, the ECB wants to keep short-term yields lower and it will do this by being flexible along the curve. The bank will likely absorb sufficient supply from governments and the market to allow 10-year Bund yields to fall all the way back to around +0.40/0.45% (spiked to a high of +0.80% early last week from +0.05% six weeks ago). The 10-year Treasury-Bund yield is also sharply higher this morning (+168 basis points) having bounced from +150 basis points last week.

This is seen as a proactive move by the ECB, confirming again that it is willing to do anything to keep rates lower. It’s effectively an increase in the size of QE, even if it’s only for a short period of time (May and June). QE is usually negative for currencies as it drives rates lower, and that’s the reason why the EUR has managed to fall so aggressively this morning (€1.1438 to €1.1173). The fact that the ECB is willing to be so flexible within its own framework has investors wondering how much further the ECB will go to achieve its growth and inflation objectives.

Separately, and providing the U.S. dollar a boost, ECB Executive Board member Christian Noyer stated the bank was ready to go further if needed to meet its mandate of maintaining inflation close to but below +2%. He indicated that the ECB’s QE program would continue until the end of September 2016 and beyond if the central bank does not see a sustained adjustment in the path of inflation. Effectively, activity slack remains an issue with the ECB.

The EUR’s subsequent break below the €1.1314 uptrend line has opened the risk to test the 20-DMA at €1.1160, and a break here will favor the EUR bears to once again test the €1.1050 region.

U.K.: No Deflation Fears

The pound’s post-U.K. election relief rally (£1.5816) seems to have come to a temporary halt, weighed down further by this morning’s negative U.K. annualized consumer-price index inflation number (-0.1%, year-over-year). Sterling bears were squeezed after the surprise election results (the market was pricing in a hung government), and now the bull is being squeezed on the way down. The pound has managed to breach its 200-DMA (£1.5596), triggering further stop losses, and according to technical charts, a close below here would open up the downside for further losses (£1.5458 short-term target).

Nevertheless, the weakness of British inflation is expected to pass. Last week, the Bank of England indicated it is doubtful that the U.K. is at risk of experiencing “deflation.” Governor Mark Carney expects the U.K. inflation rate to rise back to its +2% target by early 2017, as wage growth accelerates and oil prices recover from recent lows. The recent rise in crude prices, which are hovering near this year’s high, is mostly on the back of a cut in production and a weaker U.S. dollar, and not on traction in global growth.

Yesterday, the mighty dollar found its initial support when a Federal Reserve Bank of San Francisco white paper argued that that issues with seasonal adjustments in the U.S.’s official growth statistics had depressed winter figures, and that U.S. first-quarter gross domestic product was actually much higher than initially estimated. This has managed to put the USD on the front foot against Group of 10 currencies. Obviously, any dovish rhetoric from central bankers would only support the mighty dollar further.

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