Can Draghi Stop The EUR Ride Higher?

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 |  Includes: FXA, FXB, FXC, FXE, FXF, FXY, NZDS, UDN, UUP
by: Dean Popplewell

Part of the forex short-term market move conundrum was answered yesterday after Fed Chair Yellen's congressional testimony on Capitol Hill. Also comforting capital markets is the glimmer of hope that the Ukraine crisis tension could ease after Putin said that he was pulling troops away from their border. Later this morning, the market gets to consider the remaining two-parts of this week's forex puzzle from the BoE and ECB rate decision meetings. Will Draghi and his fellow cohorts at the ECB defend the EUR? Will Governor Carney see dissent giving rise to hawkish sentiment? Either scenario should create some volatility, hopefully a bit more than yesterday's major moves.

After a brief choppy period during the Fed chair's testimony, the market settled down with the mighty dollar ending the day little changed across the G10 board. Ms. Yellen possibly was a tad more dovish with the "rates lower for longer" remaining firmly in place. Equities stateside rode the waves and took the news well with the Dow and S&P adding +0.7% and +0.6% respectively. The risk-on mentality has so far followed through overnight, egged on by a surprisingly strong Aussie employment report (+14.2k jobs and +5.8% UE) and above expectations Chinese trade data ($18.5B). The Aussie dollar climbed to a fresh three-week high ($0.9386) while its neighbor, the Kiwi dollar, continues to trade nervously from threats by Governor Wheeler of possible RBNZ intervention ($0.8665). For now investors are riding the risk wave, forgoing and paring back safe haven trades and looking for yield, mostly with the "carry trade." With most things good there tends to be a disclaimer and that comes in the shape of uncertainties with China trade data over the next few months. Analysts warn that contracts signed at the Cantonese trade show (China's largest) dropped significantly - down -12.5% in orders from major partners. The next few months are expected to more accurately reflect the trade situation in the world's second largest economy.

The dollar's demise has been blamed on low yields, sovereigns rebalancing and safe-haven trades. However, there is a possibility that the dollar bears may be getting too far ahead of themselves. Low volatility is not necessarily symptomatic of an evolving "downtrend." There is no denying that some dollar dislikes are being influenced by the EUR hovering precariously close to that psychological €1.4000 level. Some by US yields (from mid-long) are trading at the lower end of this year's range (2.63% and 3.41%) and others by the only "carry" trades that seem to be working, which are those that are USD funded. For many, the dollar was supposed to be the "go to" trade for this year, however, the "lower for longer" and the lack of inflation pressures has caused many to reverse their long dollar positions. A large percentage of those speculators now sit relatively short. With the DXY sitting near 79, what's the risk reward of easing into long dollar contrarian positions, especially with the ECB about to be called to task as the 18-member single currency approaches supposedly "verboten" territory?

The EUR was a sideshow yesterday as the market awaits the ECB's rate decision and in particular Draghi's press conference. Euro inflation remains well below the ECB’s target level, pulled lower in part by the stronger EUR. However, coupled with stronger periphery data this week, it suggests a broader economic recovery remains in play. 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. If Draghi fails to dent the EUR with dovish rhetoric the €1.4000 barriers could quickly fall. Options traders did see a pick up in demand for €1.4000 strikes this week. Depending on the weak short positions, EUR pain threshold stop-losses strategically placed above €1.4050 could be rather attractive. Today's press conference should indicate how determined the ECB is to keeping a lid on the EUR – failing to convince could possibly establish another couple of cents on the topside.

In the case of the BoE, Governor Mark Carney and company will be closely watched in light of U.K. unemployment breaching the 7% unemployment threshold to 6.9%. Carney and company at the BoE are expected to leave the bank rate at +0.5% - the difference this time around; the market anticipates a "dissent" - someone to vote for a hike. What of the pound? The probability of cable trading through its £1.7000 level certainly increases if Draghi fails to stop the EUR trading through €1.4000. However, the lack of clear signals between here and the 2009 peak of £1.7045 has many sitting somewhat neutral. If GBP happens to close above £1.7050, it would trigger another bullish signal opening up the possibility of a £1.7300 handle print.

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