Despite the hawkish hold of the FOMC yesterday and increased confidence of a June hike, the euro is making new highs against the dollar since the US election last November. The euro is breaking out of the $1.0850-1.0950 range that has dominated since the first round of the French presidential election.
As the Great Graphic (from Bloomberg) illustrates, the euro has approached an important technical area. First, the $1.0980 area is the 50% retracement of the decline from last year's high, which was set in early May a little above $1.16. For the record, the 61.8% retracement is found near $1.1130. Second, downtrend line is drawn off that May 2106 high and the spike from the US election. It comes in today near $1.1015.
Third, the gap higher opening on April 24 has not been filled, nor even entered it. If it is a measuring gap, which takes place half way through a move, then the price objective would also be near $1.10.
The technical indicators are stretched, but only the Slow Stochastic is set to move lower. The MACDs are consistent with additional gains. The RSI is firm but below the high from the end of last month. The upper Bollinger Band is near $1.1035.
The US two-year premium over Germany recorded a two-month low on April 24 near 192 bp. Today, it rose to 203 bp before it slipped back to near 200. The 60-day rolling correlation between (the percent change) the euro and the rate differential is about 0.56, which is near the most it has been since before 2000.
The US 10-year premium over Germany peaked last December near 235 bp, which was the most since at least 1990. The premium has trended lower, and near 196 bp, it is near the lowest since the middle of last November. The 60-day rolling correlation between (the percent change) the euro and the rate differential stands near 0.63, which is the most since before 2000.
The correlations suggest that the rate differential is still key, the greater conviction that US rates are headed higher may be the key to the dollar's performance against the euro. Evidence that the US economy is rebounding in Q2, greater confidence that Trump's agenda of tax reform and infrastructure spending will be implemented may be helpful. On the other side, assuming Macron wins in Sunday's run-off, the focus will turn to the parliamentary elections next month. A safe haven bid for Bunds may re-emerge.
After the first round of the French election, the implied three-month euro volatility fell from 10% to nearly 7.5% (yesterday). Looking at the indicative options pricing, it appears the market is considerably less concerned about upcoming event risk. In the risk reversals, we note that the euro puts are still trading at a premium to euro calls, but the skew has been reduced at -0.61%, the smallest since last November. Note that the skew briefly favored euro calls in February 2016, which was the only time since 2009 that euro calls traded at a premium to euro puts.
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