Euro Driven Higher By Soaring Equity Markets

EUR/USD

The EUR/USD reached above 1.50 and is threatening to test the yearly high of 1.5061 as a pledge from global leaders to maintain stimulus efforts has fueled risk appetite. Demand for higher yields continues to be the main driver of Euro/Dollar price action as it currently explains 58% of volatility. Although slightly lower from a week ago, the pair’s correlation with risk sentiment remains at its highest level in over a decade. Meanwhile, Euro-zone interest rate expectations have decreased in significance from a week ago as the ECB remained committed to current rates at their November policy meeting. However, next year the central bank is expected to begin tightening which will bring yield expectations into focus as we start the new decade. 

ECB Interest Rate Expectations

ECB interest rate expectations sharply fell following this weekend’s G-20 meeting, where policy makers agreed to maintain low interest rates and continue stimulus efforts in order to increase the chances of a global recovery. Last week, President Trichet stated that current rates were appropriate as growth and inflation risks remain broadly balanced. Inflation risks will become the key data point to monitor going forward to judge the potential for tightening. Therefore, next Monday’s release of October’s consumer price report will have market moving potential. The early forecasts are for a rise to -0.1% from -0.3% with the core reading expected to decline to 1.1% from 1.2%. The continued disinflation in the region will allow policy makers to maintain their measured approach. Friday’s GDP report could also influence the outlook for future yields, as the economic region is predicted to have ended its recession in the third quarter with growth of 0.5%. Visit the EUR/USD Forum to discuss ECB monetary policy and other topics.

FOMC Interest Rate Expectations

The extension of the $8,000 tax credit for new homebuyers is expected to be the first of several stimulus measures that will see life beyond their initial time frame. Unemployment reaching 10.2% last month has significantly lowered the outlook for domestic growth which may the Fed to remain on hold throughout all of next year. The longer timetable for the central bank to begin its exit strategy may continue to have a weighing influence on dollar sentiment. The greenback has become the funding currency of choice making it susceptible to weakness when risks appetite rises.

Risk

Equity markets continue to march higher extending their bounce from trend line support. The pledge of continued stimulus from global leaders has markets overlooking last week’s dour labor report which showed unemployment rising to 10.2%. The move back above 10,000 for the Dow could lead to another round of flows into stocks as sidelined money looks to take advantage of the next bull rally. Nevertheless, the prospect of weak domestic growth as Americans remain out of work could limit upside potential and lead to a retrace bringingteh Euro in tow.

To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com