Consolidation The Euro Bear Enemy

by: Dean Popplewell

The first Monday after NFP is historically the least volatile day of the month. So far, this first day of North American daylight savings time is holding true to form. However, there are a number of subplots that are very much capable of widening this rather contrived forex trading range. Once the stranglehold of FX options expires, this market will become exposed to more noise.

Regional markets have been very much mixed as investors digest Friday’s above expected U.S. Non-farm payroll and the sharp uptick in Chinese CPI over the weekend. Not aiding euro periphery bond yields was the Fitch Rating credit agency cutting Italy’s credit late Friday by one notch to BBB+ with a negative outlook, citing increased "political uncertainty." It was very much expected, as this agency plays catch up to where S&P’s has been.

Released Chinese economic data over the weekend showed inflation spiking to +3.2%, y/y last month versus the +3% consensus and +2% in January, driven mostly by the Chinese New-Year base effect. This marks the highest increase in 11-months, sparking concerns that the PBoC would consider initiating some monetary tightening. Other data certainly does not initiate a warm and fuzzy feeling from the world’s second largest economy. Industrial production slowed more than expected in February (+9.9% from +10%), while retail sales for the same time period fell short of expectations, reflecting a narrow-based recovery. However, one benchmark does not make a trend. This market will insist on a few more months of data before condemning Chinese progress.

While the "big" dollar consolidates its recent gains against the JPY, the markets are subject to BoJ governor nominee and board rhetoric. Nominee Kuroda says he would do whatever it takes to defeat 15-years of deflation and achieve the +2% inflation target agreed upon by the government two months ago. While the rhetoric is not that inspiring, it certainly is news copy that is required to be heard from "a" potential future governor. BoJ policy board member Koiji Ishida pledges to carry on with aggressive monetary easing, insisting that a +2% inflation target is achievable. This is certainly food for those "massive" short yen-positions currently being nursed across the G10 board.

In the euro big picture, optimism about the eurozone recovery is probably misplaced. Despite Draghi having sounding a tad less "dovish" last week, for the masses, this does not mean that the 17-member outright currency slide won’t continue. If anything, his comments and the communiqué only highlights further the reduced inflation pressures and a grim growth outlook for the eurozone. What does this mean? The ECB and policy makers could be even more sensitive to regional data down the road.

Data releases in the coming days should be capable of emphasizing the growing divergence between the “still accommodative ECB and the increasingly neutral Fed.” Optimists are hoping that recent positive sentiment surveys will translate into a stronger economic upturn across the eurozone. If this happens, then there is no need to cut rates and the market can expect the EUR to reverse some of this recent slide. However, the EUR optimists seem to be disregarding too easily some of the harsh realities of euro periphery data revealing that the economies of most debtor countries are still contracting, and Germany alone cannot be the sole supporter. Even Draghi reminded these "debtors" last week that they couldn’t expect the ECB to provide them with help from its outright monetary transactions (OMT), until a "government" has agreed to a bailout. Italy remains govern-less after inconclusive election nearly two-weeks ago!

A positive surprise from U.S. Retail Sales and perhaps industrial production data could add further pressure to the EUR and support the “cyclical tailwinds” of the dollar across the board. Any further forthcoming disappointing euro-data certainly lends support to the argument that euro money-market rates will be forced to go lower in the regions. Any tightening of the EUR/USD spread will only put further pressure on the single currency.

So far, the EUR remains resilient considering the news flow (Italian downgrade and poor French Industrial data -1.2%, m/m this morning). Investors remain better sellers of the single currency on rallies (1.3060-90), preferred to be located atop of the weaker stop-losses placed between 1.3030-50. There is a plethora of forex options within range that the market will be expected to gravitate towards (1.30, 1.3050 and 1.2950). Until then, consolidation remains the "bear" enemy – they favor momentum trading to dominate.

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