Euro Remains Tied To Risk Despite Divergence on Greek Woes

EUR/USD

A brief bout of EUR/USD support may not last long as concerns are growing that the troubles in Greece will soon become a contagion for the region. As European leaders attempt to construct a bailout package, fears are emerging that the scope of the aid will fail to cure the country’s ills and at the same time set a dangerous precedent. EUR/USD price action has begun to diverge from risk trends as anti-Euro sentiment grows, but with a 47% 50-day correlation that relationship remains valid and must be considered in trading the pair. Meanwhile, the Fed unexpectedly raising the discount rate sent U.S. interest rate expectations soaring, increasing its influence on price action to 16% from 2% a week ago. However, the central bank has continued to insist that the Fed funds rate will remain on hold for the” foreseeable future”, which could see that relationship wane.

ECB Interest Rate Expectations

The troubles in Greece and a pedestrian pace to price growth in the region is expected to keep the ECB on hold until at least the second half of the year and possibly into 2011. Euro-zone consumer prices are expected to have risen to 1.0% from 0.9% in January from a year ago. However, forecasts are also calling for a 0.7% decline inflation during the month. Growth outside of the largest economies Germany and France has failed to materialize which continues to depress prices. Overnight index swaps continue to show a declining trend sin yield expectations with markets pricing in 66.6 bps of tightening over the next twelve month versus 109.9 at the beginning of the year. To discuss this and trading ideas join the EUR/USD forum.

FOMC Interest Rate Expectations

Fed funds futures continue to point toward the FOMC remaining on hold until after August, despite the raise in the discount rate. We did see overnight index swaps shoot to 108.8 from 70 on the unexpected policy action but have since returned to 71.5. Markets see zero chance of a March rate hike with April at 7.4%. It may take a sharp rise in inflation or a developing positive trend in job growth to push policy makers off their current stance. Housing, consumer sentiment and manufacturing data dot this week’s calendar but may be overlooked with next week’s employment data looming.

Risk

The Dow has broken above the 61.8% Fibo of the decline from this year’s peak, but has failed to clear the resistance level. The level remains valid until we see a clean break above, which leaves potential for a retracement. The expected fall in consumer confidence and weakness in manufacturing (which has been a main driver of growth) could weigh on equities. The prospect of higher interest rates will also be a concern for traders but next week’s labor report holds the greatest potential for altering the current bullish trend. 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