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Euro Diverges From Risk Creating Potential Opportunity

Euro Diverges From Risk Creating Potential Opportunity

2010-03-22 20:02:00
John Rivera, Currency Analyst
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EUR/USD

Greece’s troubles have caused ERU/USD price action to diverge from equity markets which we saw at onset of the issue. The potential that a bailout package from E.U. member nation may not be forthcoming has pressured the single currency. Risk sentiment has seen its explanatory power over the pair’s direction fall to 40% from 48% a month ago. Meanwhile, the prospect for a U.S. rate hike has improved slightly which has added weight to the euro/dollar as their negative correlation increased to 20% from 10 a week ago. We recently saw a similar divergence between the USD/JPY and equity markets which generated a profit opportunity as the currency pair saw support increase shortly thereafter, outing back on trend with risk appetite. Although, extenuating circumstances in Europe could prevent a similar reaction, the relationship should be monitored by traders if risk appetite continues.

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ECB Interest Rate Expectations

Overnight index swaps are now pricing in 67 bps of rate hikes over the next twelve months as yield expectations have begun to trend sideways with the ECB expected to remain on hold for the foreseeable future. Inflation held at 0.9% in February which is well below the central bank’s 2.0% target. Policy makers will be able to remain on hold as long as price growth isn’t a threat. The upcoming German IFO and Euro-Zone PMI reading could influence the outlook for yields if they point toward an accelerating recovery for the region. However, German officials recently expressed concerns that growth in Europe’s largest economy has been reliant in unsustainable foreign demand. Discuss this and trading ideas join the EUR/USD forum.

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FOMC Interest Rate Expectations

Rumors that the Fed will raise the discount rate for a second time before their April meeting has raised the outlook for a rate hike on Friday. The central banks continuing their language that they will keep rates “exceptionally low” for an “extended period” last week will limit the prospect for tightening. Markets are only pricing in a 28.6% chance of a rate increase by August. Upcoming existing home sales and durable goods data isn’t expected to raise the outlook for yields. Housing demand is forecasted to slip 1.4% with demand for long lasting goods expected to improve slightly by 0.5%.

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Risk

The passing of the Health Reform bill helped equity markets overcome a slow start as drug and technology shares rallied. The level of risk appetite was impressive given increase global growth concerns and troubles in Europe. The Dow is approaching pre-Lehman levels which markets could look to test before any significant pullback. Continued demand for risky assets could lead to a EUR/USD reversal as it remains the main driver of price action. Discuss this and other fundamental data join the Economics Forum.

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

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