EUR Event Premium To Remain Intact?

Markets this morning are heavy, under profit taking and somewhat disappointed at the lack of “substantive news out of the weekend’s EcoFin meeting.” It seems that the FX market space have returned to that place where volumes and participation “remain minimal, exaggerating price action.” The Euro regions finance minister have welcomed the German constitutional court decision on the validity of ESM, however, they remain divided over the banking union issue, more specifically which banks should be subjected to the body and the timing of implementation. France wants the supervision to be responsible for all banks, Germany will never give over total control. The beginning of next year seems an unrealistic target to establish a single supervisor. The pushback on the time should be immense.

Currently, risky asset prices have been boosted by QE3 and some favorable developments in the Euro region. Big picture, the dollar has and is continuing to under perform, even in an environment where Spanish and Greek risk remain high. Why the continuous decline in the USD? Traders at first were quick to point to falling US treasury yields. However, given that global yields were also sliding and US 10’s trading well above their recent July low at +1.4%, the yield argument does not appear so strong. So why is the dollar continuing to suffer?

This is the Fed’s third attempt to get things up and running. Just like before, policy makers are willing to pour liquidity into the system. Fed action thus far has failed to promote the recovery that Ben and company are seeking. Could it be because QE is simply not the solution for getting the US economy going again? It is not just the programs 1, 2 and 3, “Operation twist,” involving selling short and buying longer-dated securities to flatten the yield curve, has also been largely unsuccessful. So far, unconventional policy measures are failing to do the trick. However, we have nothing else and not necessarily on policy makers sides is required.

The ECB is in a similar situation. Euro policy makers continue to seek solutions to the debt problems of the euro zone. This month their policy makers have resorted to the “unconventional and somewhat controversial policy of introducing a longer-term refinancing operation.” However, monetary easing seems to be failing to have the much needed “trickle-down effect on the real economy.” After weeks of debate the ECB has settled on a new and radical form of unlimited bond buying (Outright Monetary Transactions). The ECB’s decision has been enough to inject a certain level of optimism and confidence into the financial markets and has helped push the yields on key euro-zone debtor countries’ bonds sharply lower.

The Fed’s decision last week was deemed as somewhat aggressive. Besides continuing to buy long bonds under the “twist” program, the Fed will add +$40b per month in buying of agency MBS securities as they launch a new round of QE, leaving them buying +$85b per month for the balance of the year under the two programs. The buying will continue until the labor market improves “substantially.” With recent economic data from China showing disappointingly slow domestic demand growth and from Japan showing that Q2 growth was revised down, the Fed is under pressure to provide an appropriate and successful stimulus package. How much time they require to produce results? We do not know. Investors have been trading high on market euphoria. Perhaps the second week give us a reality check? Do not be surprised to see some of the event premium being discarded for now.

Sept 17
According to the technicals, the market remains convinced that the single unit is heading higher, up to 1.34-3500 levels with pullbacks likely limited to levels just above the 1.30 region. European assets are expected to continue to benefit from the ECB’s new policy and a broader positive risk environment generated by the Fed’s MBS buying plan. The 10 and 30-day moving averages are positively aligned, adding to the upside potential. It seems that traction in the US economy can only save a dollar downfall, medium term at least!

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QE3 and OMT Equal a Strong EUR

This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

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