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Euro Looks to Risk Trends For Direction As ECB Expected to Remain On Hold

Euro Looks to Risk Trends For Direction As ECB Expected to Remain On Hold

2010-03-15 21:07:00
John Rivera, Currency Analyst
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USD/JPY

The euro ended a three day rally against the dollar as concerns that emerging markets China and India will look to take measures to slow their economies. A broader pull back in risk appetite has weighed on the EUR/USD which has maintained a 43% correlation with stock markets over the past month. Although the ECB hasn’t changed its position regarding monetary policy, interest rate expectations have seen tits correlation increase. The troubles in Greece have seen sentiment for the Euro and the outlook for yields move in tandem. Now that fears have eased over the potential for the credit issues to become a contagion for the region, we could see this relationship diverge as the central bank isn’t expected to raise rates until at least the second half of the year.

PD315a

ECB Interest Rate Expectations

Overnight index swaps are now pricing in 69 bps of rate hikes over the next twelve months from the ECB, which is sharply higher from 50 bps on February, 26. The region continues to show signs of continued growth with industrial production rising 1.7% in January. Upcoming E.Z. consumer prices will impact interest rate expectations and potentially the Euro. Forecasts are for inflation to have remained at 0.9% which is far from threatening the central bank’s 2.0% target. Therefore, we expect a minimal response as an inline print will allow policy makers to remain on hold. An upside surprise will put the region on a trend of accelerating prices and could spark a bullish Euro reaction. To discuss this and trading ideas join the EUR/USD forum.

PD315b

FOMC Interest Rate Expectations

Fed funds futures are pricing in a zero percent chance for a hike at the FOMC’s upcoming meeting tomorrow. Looking out to June, markets are still leaning toward the central bank leaving monetary policy unchanged with only a 15.1% chance of a rate hike. A 0.1% increase in industrial production during February beat expectations of 0.0% and adds to the improving data for the month. However, we have seen very little movement in yield expectations as the central bank has been unwavering in its commitment to leave rate on hold for an “extend period”. Markets will be watching to see if the central bank removes the “extended period” language from its post decision remarks, as Kansas City President Thomas Hoeing has lobbied to raise rates in the near-term and alter current rhetoric. A change could spark a bullish dollar reaction and sink the pair.

PD315c

Risk

The Dow has continued to trade within a wedge formation and we have become a broken record predicting a breakout. However, it is when you grow tired of the pattern that you see an increase in volatility. The upcoming FOMC rate decision could be a catalyst for such a change in sentiment. A downside move is favored with dimming expectations for global growth. However, markets are irrational and upside potential remains. Discuss this and other fundamental data join the Economics Forum.

PD315d

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

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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