EUR/USD: The Week Ahead

Includes: FXE, UDN, UUP
by: Vision Capital M.

In this series of articles, we cover economic and political events expected to happen during the week ahead, which have the potential to make a significant impact on major foreign exchange rates. Some of the events will also affect equities and fixed income markets. Although the latter ones will not be the main focus of the articles, the possible effect on them could sometimes be examined, too.

The articles also include information on the large positions of the futures traders in the examined currencies or equity indices.

EUR/USD Currency Pair

The pair started the week with a small decline to 1.2490 and continued to move between that level and 1.2575/80 where it finished on Friday. The weekly increase (about 0.5%) was not so steep as the previous week, but was fueled on the last day by the speech of the Fed Chairman Mr. Bernanke at Jackson Hole. A Bloomberg article reveals that he iterated his trust in the "effectiveness of unconventional monetary policies such as bond purchases and signaled he would soon deploy them again to attack unemployment." In a Bernanke's opinion published in The Washington Post about 2 years ago, the reader can take a deeper look at the Chairman's beliefs and the way he thinks monetary easing would affect stock prices, long-term interest rates, consumer confidence and spending and economic growth.

During the week, the U.S. economy showed some signs of improvement with the Dallas Fed and Richmond Fed Manufacturing indices showing better values than the estimates and the previously recorded ones. Pending home sales were also better than expected and recorded a growth of 2.4% (up from -1.4%). The Reuters/Michigan Consumer Sentiment index increased to 74.3 from 72.3 and also surpassed the estimate of 73.6. The Factory orders (month-over-month) were another estimate surprise and added to the positive tone with an increase of 2.8% from the previous value of -0.50%.

On the negative side was the consumer confidence whose value of 60.6 was below the estimate of 66 and the previous reading of 65.4. Unemployment continues to be the biggest hurdle before the U.S. economy as stated in the recently released Beige book and the speech of Mr. Bernanke. The data on jobless claims, which mostly remained unchanged, supported that conclusion.

The events flow resulted in a sideway movement of the EUR/USD pair during the past week with a break on the upside on Friday caused by the market expectations of more QE on behalf of the FED.

Any possible appreciation of the euro could be played by a long position in the CurrencyShares Euro Currency Trust (NYSEARCA:FXE). This ETF tracks the EUR/USD currency rate and has an expense ratio of 0.40%. If one expects the euro to depreciate against the U.S. dollar, a short position in the same ETF could be used.

Another option is to open positions in the DB USD Index Bullish (NYSEARCA:UUP) ETF or in the DB USD Index Bearish (NYSEARCA:UDN) fund. Both track the value of the USD against a basket of six other currencies and have an expense ratio of 0.50%.

Important economic data releases on Monday:

  • Germany Markit Manufacturing PMI (Aug) - 7:53 GMT / 2:53am EST
  • EMU Markit Manufacturing PMI (Aug) - 7:58 GMT / 2:58am EST
  • ECB President Draghi's Speech - 13:30 GMT / 8:30am EST

The current week starts with a day off in the U.S., so the markets during Monday will be dominated by European and Asian traders. The volatility, however, could remain elevated especially in the early European afternoon as the ECB President Mr. Draghi will give his speech at 13:30 GMT. If he gives any hints about the means the ECB would use in order to support liquidity and provide financial help to troubled EU members, the markets could support a stronger euro. Any providing of additional monetary easing in real could weigh on the euro's price in long-term, but initially it is expected to support the single currency as the markets would like to see coordinated and decisive actions in Europe. Such actions, however, even if supported verbally by the ECB President, could face an opposition from the more conservative members like Germany or the Northern countries before being put to practice. In short term, however, the verbal support could do its work and lead to an euro appreciation.

Any surpassing of the highest level of 1.6230/40 achieved during the last week could make the euro capable of testing the resistance line around 1.2700/30, which level also lies on the downtrend line.

The other economic data on Monday, particularly the Markit Manufacturing PMIs which track the business activity in the manufacturing sector, could also provide some volatility, but not as strong as Mr. Draghi's speech. The consensus estimate for the EMU indicator is 45.3, up from the previous reading of 44.

Update as of 09:00 GMT on Monday: The Markit PMI readings for Germany and EU released today show the values are below the consensus estimates. There is an improvement in the business conditions, but not as much as the market expected with the miss in Germany's value being bigger than the EMU ones. The EUR/USD rate reacted by a slight depreciation of the euro.

Important economic data releases on Tuesday:

  • EMU Producer Price Index (year-over-year and month-over-month) (Jul) - 9:00 GMT / 4:00am EST
  • USA Construction spending (month-over-month) (Jul) - 14:00 GMT / 9:00am EST
  • USA ISM Manufacturing PMI (Aug) - 14:00 GMT / 9:00am EST
  • USA ISM Prices Paid (Aug) - 14:00 GMT / 9:00am EST
  • USA Total vehicles sales (Aug) - 21:00 GMT / 16:00am EST

The consensus estimates for the producer price index in the European monetary union on a month-over-month basis is 0.3%. This is an increase from the previous reading of -0.5%. The previous value for the year-over-year measure is 1.8%. Surprising values significantly above the previous readings could signal a possibility of higher inflationary pressures in Europe. This could support the euro in long term as it would mean a more hawkish ECB policy, but the currency could suffer in short term as the markets currently expect the ECB to be more pro-easing.

The reading of the ISM Manufacturing PMI could have a significant impact on EUR/USD volatility. The market expects an increase to 50.1 from the previous value of 49.8. Any negative surprise on this could send the euro higher against the U.S. dollar.

The ISM Prices paid value is regarded as a business sentiment indicator of inflationary expectations. The consensus estimate is a growth to 47.8. Any value lower than this could cause a depreciation of the USD. It would also mean the Fed would be able to promote further monetary easing in an environment of lower inflation expectations.

The markets expect vehicle sales to decrease to 14.1M from 14.5M. A positive surprise on this could lead to an USD appreciation.

Important economic data releases on Wednesday:

  • Italy 10-y bond auction - N/A
  • Spain 5-y bond auction - N/A
  • EMU Retail sales (Jul) - 9:00 GMT / 4:00am EST
  • USA Nonfarm productivity (Q2) - 12:30 GMT / 7:30am EST
  • USA Unit labor costs (Q2) - 12:30 GMT / 7:30am EST

The Italian and Spain bond auctions will show if the markets have trust in the words of the European officials. A further decline of the yield would support the euro, while an yield increase would weigh on the single currency.

Retail sales in Europe are expected to decline further, both on a monthly and yearly basis. The previous readings were 0.10% and -1.2%, respectively. Any positive surprise signaling an increase in retail sales would be supportive to the euro.

The consensus estimate for the U.S. non-farm productivity is for it to increase to 1.8% from a previous reading of -0.9%. Any significant deviation from the estimate would drive the U.S. dollar in the same direction as the deviation.

Unit labor costs are used as an indicator of inflationary expectations and business costs. Markets expect a decrease to a value of 1.5% (from 5.6%). Any reading above any of those values would mean upside pressure on wages in the U.S. continues, which would be supportive to the USD.

Important economic data releases on Thursday:

  • EMU GDP (Q2) - 9:00 GMT / 4:00am EST
  • Germany Factory orders (Jul) - 10:00 GMT / 5:00am EST
  • ECB interest rate decision - 11:45 GMT / 6:45am EST
  • EU Rajoy - Merkel meeting - 12:00 GMT / 7:00am EST
  • ECB Monetary policy statement and press conference - 12:30 GMT / 7:30am EST
  • USA ADP employment change (Aug) - 12:15 GMT / 7:15am EST
  • USA Jobless claims - 12:30 GMT / 7:30am EST
  • USA ISM non-manufacturing PMI (Aug) - 14:00 GMT / 9:00am EST

The markets expect the EU GDP on a monthly basis to be negative still, but at a slower speed. The consensus estimate is -0.2% and the previous value is -0.3%. The previous reading on an annual basis is 0.7%. Any negative surprise on both indicators would weigh on the euro.

The same is valid for the Germany factory orders, which are expected to present better readings than the previous ones of -1.7% M-o-M and -7.8% Y-o-Y.

The market expects the ECB to decrease its interest rate to 0.5%, down from the current level of 0.75%. Given the not-so-booming European situation, such a decrease seems reasonable. A decrease below 0.5% currently seems a more risky move as the CPI level in EU released last week shows that inflation increased to 2.6% which is above the 2% threshold set by the ECB. A surprising interest rate decrease to a value below 0.5% could weigh significantly on the euro in long-term, but be supportive in short term, given the decisive measures the market participants expect from the ECB.

The EUR/USD pair could see an increased volatility in the couple of hours following the ECB rate decision because of several important events during this period, including the meeting between the German Chancellor Merkel and the Spanish President Rajoy and the ECB press conference. They could signal further hints on the future course of actions of the European officials and thus significantly impact the single currency's value.

On the other side of the Atlantic, the employment data is expected to continue to deteriorate. Any positive surprise there could support the USD.

With a consensus estimate of 52.5, the ISM non-manufacturing PMI is expected to stay almost the same as the previous reading of 52.6. Any surprise on the reading should send the dollar in the direction of the surprise.

Important economic data releases on Friday:

  • Germany Trade data (Jul) - 6:00 GMT / 1:00am EST
  • France Trade data (Jul) - 6:45 GMT / 1:45am EST
  • Germany Industrial production (Jul) - 10:00 GMT / 5:00am EST
  • USA Average hourly earnings (Aug) - 12:30 GMT / 7:30am EST
  • USA Non-farm payrolls (Aug) - 12:30 GMT / 7:30am EST
  • USA Unemployment rate (Aug) - 12:30 GMT / 7:30am EST

The Germany trade data to be released include the Current account, Trade balance, Exports and Imports. The market expects the trade balance to decrease to €15.4B from a reading of €16.2B. A positive surprise here could lead to an euro appreciation.

The same is valid for the Germany industrial production. A reading above the previous one of -0.3% (y-o-y basis) could signal strengthening of the German economy and be a positive euro factor.

The France data include the Budget, Exports and Trade balance. The market consensus is for the trade balance to improve to a value of €-5.60B.

The consensus on the change in U.S. average hourly earnings is that it will increase a bit on a monthly basis to 0.2% from a value of 0.1%. This serves as an indicator of the possible price pressure and labor cost inflation. An increase above the consensus could signal increased inflationary pressures and would be USD supportive.

As unemployment continues to be among the biggest problems the U.S. economy faces, the non-farm payrolls and the unemployment rate are closely watched. The consensus is that unemployment will stay the same as the previous reading of 8.3%. Any surprise on this would drive the USD in a direction contrary to the surprise. Moreover, a positive surprise by a lower number would relieve some of the pressure on the Fed to use another round of QE to support the economy.

Futures traders positions

The U.S. commodity futures trading commission reported last week that noncommercial traders (the traders that do not use futures mainly for hedging) continued to decrease their net short positions on the euro, but at an accelerated speed. Those positions decreased from ~170T to ~147T for a week. The previous decrease was of about 11T, so now we see the speed of liquidating shorts almost doubled. The net long positions marked a slight decrease of 59 and virtually stayed the same at ~46T.

The steep decrease in the short positions could have been the cause for the 2% increase of the euro we witnessed the week before the last one.

Commitments of traders

The noticeable trend of decreasing the short positions and increasing the long ones, which was valid for almost the whole last two months, continues on the short side but is somehow stalled on the long one. Currently, the short positions in the EuroFX are at the lowest level for the last 3 months, while the long ones are not increasing at the same speed. The short positions are also below the average value for the 3 months and year-to-date periods while the long ones are above their average value. The low level of shorts could show an exhaustion of the buying power toward the euro.

Having in mind the above presented configuration and the EUR/USD course of the exchange rate during the last week, a reverting to the mean value could be expected on the short side. An increase in the net short positions could weigh initially on the euro but increase the possibility of a further appreciation due to a short covering in future. A more clarity on the ECB and Fed's policies and actions in the coming weeks will further affect the traders' positions.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.