Investors continue to search for solid reasons for some of the current forex market moves. Sterling and EUR have been easy as investors cite yesterday's somewhat surprising PMI headline prints; however, the dollar's move is more of a mystery. Its change of late cannot be explained by rates or even the reversal of safe-haven trades alone. Nonetheless, the fact that long-end yields of the US curve continue to fall, despite building evidence that a strong economic recovery is underway, seems to be undermining investor confidence in the mighty dollar. In fixed income, long US product is trading more like a commodity, with demand for product smothering supply and artificially weighing even more on yields than the Fed's QE intentions. Dealers have cited other reasons for the dollar demise and have noted central bank and pension fund buying – rebalancing of reserves and portfolios. All good enough reasons, but the market wants more. Investors will look stateside today and focus on Ms. Yellen and the US 10-year auction for dollar direction.
Expect the market to be glued to the Fed head's congressional testimony to see if she has a message that alters the Fed's monetary policy. Falling US yields are hurting the dollar and certainly making equity markets a tad more nervous. So far the Federal Reserve's forward guidance is keeping a lid on rate-hike expectations and allowing the dollar to be treated with "benign neglect." After avoiding a press conference at last week's Federal Open Market Committee meeting, and mostly skipping monetary policy themes in a speech last Thursday, Ms. Yellen may be forced to clarify her thoughts on the US economy. The market will be looking for anything in reference to last week's supposedly strong jobs report. For others, they will be watching today's US $24b 10-year note auction for clues. US 10s are straddling +2.60% yield, close to the bottom of a range it's been in since January. Traders will want to see if the market needs to make a concession to attract buyers.
Ms. Yellen is not the only central bank to influence market direction this week; tomorrow is the ECB and BoE's turn. Monthly interest rate decisions for both central banks could make it rather interesting for investors. In the case of the BoE, Carney and company will be closely watched in light of UK unemployment breaching the 7% unemployment threshold to 6.9% - this could put the discussion of rate hikes on the table, giving rise to possible dissent amongst the ranks on the MPC.
For the ECB all good data of late provides a problem for policy makers. Euro inflation is well below the ECB's target level, pulled lower in part by the stronger EUR, and the rebound so far has been mild and in theory sets the scene for further easing measures. Nevertheless, stronger PMI prints this week suggest a broader economic recovery remains in play. Draghi and company cannot afford to be too aggressive in either direction as the balance of growth is precarious. 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. Unless there is a surprise from Yellen – remember the six-month statement in March – EUR and GBP moves are likely to remain limited until investors get guidance from either central bank.
Assuming the EUR remains close to today's option expiries (€1.3930), the single currency has the potential to test the highly touted psychological €1.4000 level if the ECB stands pat tomorrow. This level was a previous print that the ECB defended with increased rhetoric. A scarcity of expiries, low volatility and minimal spec longs suggest that there could be little to prevent a clear break higher. Momentum trades through key resistance and support barriers tend to be followed up with a good size move. However, the danger is the proximity to this key level – it could provoke an unexpected and aggressive response from the ECB, which in that scenario could create a sizeable pullback. Either way the market is surely to remain tentative when strapping on positions, as they would prefer to be flexible if and when they are required to reverse direction. If the ECB defends, the next question will be how low can the EUR go? That will depend on what arsenal ECB policy makers will be using on the next go around.