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Euro’s Relationship with Risk Firms As European Troubles Dictate Broader Sentiment

Euro’s Relationship with Risk Firms As European Troubles Dictate Broader Sentiment

2010-05-17 20:49:00
John Rivera, Currency Analyst
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EUR/USD

The Euro reached a four year low of 1.2218 against the dollar today as concerns grew that the debt issues in Europe could become a drag on the global economy. Investors remain worried that Greece, Portugal and Spain among others will need to enact painful budget cuts to reduce their debts. The EUR/USD is re-establishing its correlation with risk trends as the single currency’s troubles continues to dictate broader sentiment. Indeed, the relationship with the pair and the Dow firmed to 42% from 33% a month ago. We have also seen yield expectations for the region decline as growth prospects dim which has seen its correlation strengthen to 39% from 26 over the past month. Meanwhile, the Fed is expected to remain on hold for an extended period which has negated its direct impact on price action. However, as long as accommodative policy is in place the longer the dollar will remain a funding currency making its crosses negatively correlated with risk.

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ECB Interest Rate Expectations

Overnight Index Swaps moved off of their low of 24.4 on 5/14 to 29.9 but markets continue to price in little chance of a rate hike in the next year from the ECB. The trend is clearly to the downside and the dimming prospect of tightening has also been driving the single currency lower. Tomorrow we may start to see the impact from the debt crisis reflected in fundamental releases with the German Zew survey scheduled to cross the wires. Economists are forecasting that investor sentiment fell to 47.0 in May from 53.0 the month prior. This could add additional weight on yield expectations and the Euro. A sharp rise in inflation may be the one development that could raise the outlook for tightening, but the pace of consumer prices in the Euro-Zone is predicted to have remained unchanged at 1.5%-well below the central bank’s 2.0% target. Discuss this and trading ideas join the EUR/USD forum.

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FOMC Interest Rate Expectations

Fed fund futures continue to point toward the FOMC remaining on hold until at least the end of 2010 as markets continue to price in a 79% chance that rates will remain unchanged through September. It may take a drop in the unemployment rate which rose to 9.9% in April before the central bank considers employing a tightening policy. However, the other catalyst for a rate hike could be soaring inflation which adds importance to this week’s release of April’s consumer price index. Price growth is forecasted to have slightly accelerated to 2.4% from 2.3% the month prior. However, we may need to see inflation top 3.0% before the alarms start ringing at the FOMC given their focus on job growth.

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Risk

A late rally in stocks helped the Dow close in positive territory and the source of support could be rooted in the Euro’s ability to retrace earlier losses. A record net TIC flows of $140.5 billion for March shows that foreign investors are seeing the U.S. as one of the most attractive markets to invest which may have also boosted confidence in U.S. equities. However, a sharp fall in the Empire manufacturing survey to 19.11 from 31.86 on the back of weaker orders has raised concerns that the boost from the inventory cycle is coming to an end which could weigh on growth forecasts. Technically we could be seeing a supporting trend line develop which could limit downside risks, but a move lower to re-test 10,000 can’t be ruled out at this time. Discuss this and other fundamental data in 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

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

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