What's The EUR To Do - Ignore The Soft Facts?

by: Dean Popplewell

It seems that Wall Street has apparently decided to ignore the run of current weak US data due to the bad weather and instead gladly focus on M&A activity across the developed stratosphere in belief that all is well in capital markets. This week's sharp turn higher in investors risk appetite is helping the likes of commodity prices to once again find firmer footing. This sector is beginning to bounce back nicely from last week's China-related concerns. Both the AUD and CAD, commodity and interest rate sensitive currencies have been helped by the fact that USD/CNH has someone settled down with more influence from authorities rather than investor positions.

Again, the major currencies remain rather stable and still show little sign that they want to break out of their contained ranges. The 18-member single currency has tried to rally, following the better than expected German Ifo report yesterday, however, heightened speculation that Draghi and his fellow policy makers may be considering more easing action at next week's meeting is discouraging any breakout higher by the single currency. Technically the currency continues to run into a plethora of sellers currently residing north of €1.3775. It was forced lower not on fundamentals, but on the back of Ukraine's current fallout situation where eager buyers prefer to flip their positions ahead of the psychological €1.37 handle.

The difference in global investor mood is currently bi-polar in attitude. Stateside investors remain remarkably optimistic and resilient in their opinions. The majority expects the US economy to come through this weather related malaise in its stride. So much so that the ongoing emerging market issues are not weighing down any developed nation investors' risk appetite like it has done in recent months. It seems that the shift in investors' individual moods and central bank expectations have resulted in most currency pairs to be whipped about intraday in a very trendless fashion. The forex market seems intent to trade within confounds of these recent ranges.

As the week progresses everyone is beginning to become more concerned with what Draghi and company is about to do. The fact that the eurozone is flirting with deflation may force ECB to act sooner rather than later. What about next week? Over the medium term, many see downside risks to both growth and inflation in the region, unlike the ECB’s more balanced view. A lack of further policy action may undermine President Draghi's and his fellow members' credibility to tether longer-term inflation more closely to +2%. The lack of sound policy initiatives being implemented, or worse still, the ability to lose the faith of the trading public, has the potential of putting the EUR in much deeper water. This market has been short the single currency for a very long time and it has more to do with the "mighty" dollar's lackluster performance rather than the EUR flight that has been undermining a potential winning position.

Looking at most of the majors' trading patterns there is perhaps one willing to forgo the natural trading path to true value and that's the Chinese renminbi. It's seems to be in a battle between policy makers who believe that PBoC currency is close to its fair value and to others who obviously disagree. Current, sometimes wild domestic interpretation of fundamentals (when the developed world requires stronger fundamentals – China conveniently delivers) supports those who expect further currency appreciation over the medium term. The ever-present PBoC will surely create some volatility along the way. A train of thought believes that the CNY will break through that psychological CNY6.00 handle sometime this year. Investors are heavily positioned that way. This is not going to happen if Chinese policy makers get to have their own way.

In overnight trading the yuan fell to a six-month low outright (CNY6.1310). It seems that the PBoC's continued efforts of pushing the currency lower are finally paying off – causing a short squeeze in the onshore market. The CNY has depreciated -1.5% from its record high vs. the USD set last month and has fallen -1.2% year-to-date after appreciating +2.9% last year. Offshore investors can expect the PBoC to continuing intervening and weaken the CNY further or at least until they have convinced the "offshore" investors to change their bullish views. Ongoing moves like this will require Chinese trading authorities to widen the trading range.

It's rather difficult to get overly excited over any other asset class. Money remains cheap; stocks are performing, as they should, albeit above valuations. But looking at the various other asset classes, the lack of volatility does not warrant investors to change their trading whole-heartedly just yet. US Treasuries seem to have been stranded for months. Their yields spiked nearly a year ago, last May, when "tapering" was first suggested. Ever since US 10s have been wrapped between +2.5% and that psychological +3% level, even through the ongoing EM fallout. This ideal scenario is not sustainable especially now that the US economy seems to be on the road to recovery, with or without weather issues. Before long, Ms. Yellen will be touting other policy guidance issues, well removed from the "tapering debate" and something that should get US longer-term yields finally moving higher again.

Forex heatmap