FXE Will Break Out If There Is No Rate Hike At The April FOMC Meeting

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Includes: DRR, ERO, EUFX, EUO, FXE, FXY, JYN, ULE, URR, YCL, YCS
by: Ed Wijaranakula

Summary

The pullback in the euro against the U.S. dollar is driven by hawkish remarks from a number of Fed Chair Janet Yellen’s dissenters.

The currency market is now beginning to price in the odds of a rate hike at the Fed’s April FOMC meeting.

The currency pair will likely break out the resistance level if there is no rate hike announcement at the next Fed meeting.

The Guggenheim CurrencyShares Euro Trust (NYSEARCA:FXE), which tracks the EUR/USD exchange rate, pulled back following a two-day Federal Open Market Committee (FOMC) policy meeting on March 15-16, despite that the U.S. Federal Reserve kept the key interest rate unchanged at between 0.25% and 0.5% and hinted that they may make only two rate increases by the end of the year, half the number that was forecasted at its December meeting. The Fed also trimmed its economic growth outlook for the year to 2.2%, from the previous forecast of 2.4% growth, and its forecast for inflation to 1.2% from 1.6%.

FXE Technical Chart Click to enlarge

In the past few days, the FXE and EUR/USD continued to lose ground after a number of Fed Chair Janet Yellen's dissenters started making hawkish remarks. Here is how CNBC Senior Economics Reporter Steve Liesman, put it, "Fed Chair Yellen has a mini revolt on her hands". Federal Reserve Bank of St. Louis President James Bullard, one of the U.S. Federal Reserve's most prominent advocates of higher interest rates, who told Reuters in February that it was "unwise" to move any further in light of weak inflation and global volatility, seems to have second thoughts.

EUR/USD Technical Chart Click to enlarge

Mr. Bullard now says that policymakers should consider raising interest rates at their next (April) meeting, amid a broadly unchanged economic outlook and prospects of inflation and unemployment exceeding targets, according to Bloomberg. Traders might still be looking at the economic data, but they seem to be putting weight to the hawkish views of the voting members of the FOMC, including those of Mr. Bullard.

U.S. Economic Outlook May Not Be That Rosy

The U.S. dollar index, or DXY, a weighted index of the value of the U.S. dollar relative to a basket of six major currencies, about 57.6% euro weight, is on the rebound, from a 5-month low, in response to Fed officials' hawkish remarks. The euro will be under selling pressure as the DXY is heading to test the near-term resistance at around 97, or the upper trendline resistance of the descending chart pattern. Economic headwinds could derail the dollar's upward move since the U.S. economic outlook may not be as rosy as painted to be and the Fed's rate hike path is still uncertain.

The U.S. Dollar Index Technical Chart Click to enlarge

There are warning signs that something is wrong with the U.S. service sector, accounting for nearly 80% of the private sector gross domestic product, or GDP. The reading of the Markit Economics monthly flash services purchasing manager's index, or PMI, came in at 51 for March, after plunging to 49.7 in February, missing the estimate of 51.4. A reading above 50 means the service sector of the U.S. economy is expanding.

In the press release, Markit Chief Economist Chris Williamson said:

Worst may be to come. The greatest concern is the near-stalling of new business growth. Demand for goods and services is growing at the slowest rate seen this side of the global financial crisis. It's not surprising therefore that companies lack pricing power, as reflected in a near-stagnation of average selling prices in recent months.

In the recent Markit report, "Faltering U.S. Economy Leads Global Slowdown", Williamson believes that if the Fed keeps further rate hikes on the table, slower economic growth may soon feed through to weaker hiring despite that surveys and official data showed job creation remaining robust.

U.S. consumers are feeling less optimistic, as concerns about prospects for the economy and expectations that gas prices would inch upward during the year are on the rise. The preliminary reading of the Index of Consumer Sentiment by the University of Michigan in March was the lowest in three months. Weak consumer sentiment clouds the already sluggish U.S. retail sales, as the Commerce Department data showed that January and February sales were contracting for two months in a row. U.S. retail sales have trended lower since it peaked in March 2015, at 1.5% month-over-month growth.

Rising mortgage rates prompted panicked home buyers to rush into the market while sellers were hiking up prices in anticipation that more people would be looking for houses. The National Association of Realtors said this week that sales of previously owned homes tumbled 7.1% in February from the prior month. New single-family homes sales, accounting for 9.2% of the housing market, showed a 38.5% surge in the West, but sales in the Northeast and Midwest plunged 24.2% and 17.9%, respectively.

Weak British Pound Sterling Supports Euro

The euro has been strengthening against the British pound sterling, despite that the European Central Bank (ECB) announced earlier in March, at the Governing Council meeting in Frankfurt, that the central bank raised monthly asset buys to 80 billion euros, from 60 billion euros, and cut its main refinancing rate to zero from 0.05%. The above-expectations QE came with a negative spin though, as ECB President Mario Draghi said after the ECB monetary policy meeting that the central bank doesn't anticipate that it will be necessary to reduce rates further.

The pound continues to be under selling pressure following last week's terrorist bombings at the Brussels airport and Metro station that left at least 34 people dead and scores injured. Nigel Farage, leader of the pro-Brexit, anti-immigration United Kingdom Independence Party, blamed the blasts on the EU's freedom of movement rules and accused Britain's pro-EU politicians of "putting lives at risk for the sake of political union". He also suggested the attacks could strengthen the campaign for Britain to leave the EU in the U.K. referendum, to be held on June 23.

GBP/EUR Techncial Chart Click to enlarge

Technically, the GBP/EUR just broke down the descending broadening wedge chart pattern and is bumping along the trendline support at around the 1.268 euros per pound level. The downtrend could linger, as the long-term sentiment for the British pound sterling is bearish while the referendum and U.K. politics continue to be a dark cloud throughout the first-half of 2016. The next key technical supports are 1.255 euros per pound, or the 61.8% Fibonacci retracement level, and 1.243 euros per pound, respectively.

Strong Yen Is Unsustainable

Concerns about weakening global economies and aggressive Fed rate hikes put buying pressures on the Japanese yen as a safe-haven currency. The FX currency traders have shrugged off the possibility that Japan's economy could fall back into recession, considering that the Cabinet Office of Japan said last week that Japan's GDP shrank an annualized 1.4% in the fourth-quarter 2015, as weakness in private consumption, which accounts for about 60 percent of the economy, persists.

According to Barron's, Prime Minister Shinzo Abe will introduce a big fiscal package, somewhere between 5 trillion ($44 billion) and 10 trillion yen ($88 billion), in the second-quarter this year. The fiscal stimulus package will likely come before the elections for Parliament in July.

EUR/JPY Technical Chart Click to enlarge

Technically, the EUR/JPY cross rate bounced off the key technical support at 121.90 yen per euro, or the 50% Fibonacci retracement level. Additional stimulus from Abe's government could put pressure on the yen and the currency pair could break out from the descending wedge chart pattern at around the 127 yen per euro level.

Conclusions

The pullback in the euro against the U.S. dollar is driven by hawkish remarks from a number of Fed Chair Janet Yellen's dissenters. The currency market is now beginning to price in the odds of a rate hike at the Fed's FOMC meeting on April 26-27. Until then, we expect the EUR/USD to continue weakening to the trendline support of the ascending broadening wedge pattern, at around the $1.10 per euro level. The currency pair will likely break out the $1.14 per euro resistance level if there is no rate hike announcement at the next Fed meeting. The FXE breakout level is 114.81. The recent Markit PMI, U.S. retail sales, and housing data show that the U.S. economic outlook may not be as rosy as painted to be. The weak U.S. economy, British pound sterling and Japanese yen support the strong euro argument.

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