A Little More Inflation Than Expected Carries The Euro Far

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Includes: FXE, UUP
by: Duru

Summary

Inflation in the eurozone is expected to come in hotter than expected for May.

The euro soared in response and led a general rally against the U.S. dollar.

While the dollar now seems poised to extend its downtrend from the recent peak, I decided to fade the trigger-reaction to inflation assuming the ECB will talk it down.

Technical cues will help guide me after the reaction to the ECB meeting. For now, I am essentially anticipating rangebound action.

The eurozone reported inflation slightly higher than "expected" for April, 2015. The "beat" was enough to ignite CurrencyShares Euro Trust (NYSEARCA:FXE) for a 2% gain on the second day of June. The most interesting component of the euro's surge was that it seemed to lead an anti-dollar contagion that sent the entire dollar index plunging and stopping well short of a retest of the downtrend from the recent peak. The U.S. dollar (NYSEARCA:UUP) lost against all major currencies - even the buckling Japanese yen (NYSE:FXY) recovered all its losses from Monday's dollar surge.

The U.S. dollar confirms the downtrend from the recent peak as it falls short of the downtrend line and returns below a now declining 50-day moving average

The euro surges off recent lows and seems poised to reverse its losses from the last peak

Source for charts: FreeStockCharts.com

The headline driver for the dollar's surge on the previous day was exceptionally strong economic data from ISM Manufacturing and, in particular, construction spending. It is telling that it only took data from across the Atlantic pond to immediately erase those gains and then some. The market is trigger-happy and very sensitive to economic data as market participants try to quickly connect the dots to monetary policy.

Just as easily the euro gained, I am expecting it to lose. The euro's strength presumably came from a resurgence of anticipation of an early end to quantitative easing from the European Central Bank (ECB). The ECB gets another opportunity to dispel such notions on Wednesday morning during its June meeting on monetary policy . (several hours away at the time of writing). Even if the ECB passes on this opportunity, the actual inflation data does not strike me as strong enough to suggest QE will or even should end early. The ECB already over-reacted to a slight whiff of inflation soon after the financial crisis subsided; the central bank should now be loathe to repeat this mistake and could even prefer to err on the side of leaving rates low for too long.

Overall inflation is expected to hit 0.3% year-over-year for May. This will be an improvement from April's flat reading. From Eurostat:

Inflation in the eurozone returns to positive territory despite a large negative component from energy

Source: Eurostat

Inflation excluding energy is expected to hit 1.0% year-over-year. Excluding energy, food, alcohol & tobacco this inflation goes to 0.9%, up from April's 0.6% inflation reading.

According to DailyFX.com, the core inflation rate was expected to hit 0.7%. So just a little hotter was enough to send the euro soaring and the rest of the basket trading against the U.S. dollar - quite an awesome display of trigger-happy trading!

Given my expectation that the ECB will be motivated to speak against the stubborn attempts to front-run the end of QE, I started to fade this move. Note from the chart above the euro has returned to the assumed upper trading range, so I have started small in case the euro extends toward the top of the range again. Trading ahead of the ECB meeting also requires caution in case I misread what the ECB is likely to do.

On the technical side, the time for shorting may again be reaching the point where risks outweigh potential rewards. The 50-day moving average (DMA) has taken on a definite upward slope. This important moving average is likely to provide even firmer support the next time the euro drops toward it. A break of recent lows around 1.082 on EUR/USD returns the euro to a firmer bearish technical pattern.

Be careful out there!

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In forex I am short the euro