Euro Regains Footing As Risk Appetite Re-Emerges, Will NFP’s Derail Momentum?

EUR/USD

The Euro has regained its footing as risk appetite has returned with concerns over the Dubai debt default dissipating. Improvement in Chinese, Swiss and Euro-zone manufacturing has helped spur bullish sentiment sending equities and the EUR/USD higher. Indeed, stocks remain the main driver of the pair’s price action, currently explaining 62% of volatility. However, despite improving fundamental data and the RBA’s aggressively tightening, the ECB and Fed are expected to remain on hold limiting the impact of interest rate expectations on price action.

ECB Interest Rate Expectations

The upcoming ECB interest rate decision isn’t expected to have any long-term impact on price direction as the central bank is forecasted to remain on hold at 1.00%. However, we could see policy makers change the tone of their rhetoric with growth on the rebound and inflation expectations rising. The latest Euro-Zone CPI estimate jumped to 0.6% from -0.1% which was the first increase in seven months. Yet, President Trichet has remained consistent with his expectations that inflation will moderate over the medium term allowing the committee to take a measured approach. Higher oil prices have started to put upward pressure on headline inflation, but until we start to see rising wages and robust consumer demand, there is little cause to raise rates. Indeed, we saw Euro-zone unemployment hold at the eleven year high of 9.8% in October. Yet, the number of out of work Germans dropped by 7,000 in November and retail sales rose 0.5% in the region’s largest economy. Nevertheless, overnight index swaps continue to trend lower and are currently only pricing in 82 bps of rate hikes in the next twelve months. To discuss this and trading ideas join the EUR/USD forum.

FOMC Interest Rate Expectations

U.S. interest expectations have flat lined with markets only pricing in only a 10.9% chance of a rate hike by March. It isn’t until September that we see a rate hike as the most likely possibility according to Fed Fund futures. November’s labor report scheduled for release on Friday holds the largest potential to alter policy maker’s direction. Non-Farm payroll jobs are expected to have decline by 123,000 which would be the lowest since March, 2008 and a print close to even could raise expectation for job growth and in turn tightening from the FOMC. Regardless, the main catalyst for tightening from the central bank will be inflation and will prices still declining that could be in the distance.

Risk

The Dow made a new yearly high today and is looking to test trendline resistance which is near 10,600. The consistent improvement in manufacturing data from China to the U.S. (although declined –expanded for fourth straight month) has helped fuel optimism. Pending home sales rising to the highest level in over three years also added to bullish sentiment as the sector saw a 31.8% improvement from a year ago in October. Employment data the rest of the week holds the key for sentiment with an improving labor picture bullish for the EUR/USD. To discuss this and other fundamental data join the Economics Forum.

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