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Euro Sentiment May Start To Lose Influence on Broader Trends, If Growth Signs Continue.

Euro Sentiment May Start To Lose Influence on Broader Trends, If Growth Signs Continue.

2010-05-24 18:01:00
John Rivera, Currency Analyst
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EUR/USD

The Euro got off to a rocky start on the week as Spain’s rescue of a local bank reignited concerns over the region. The single currency has erased a significant amount of its recent gains. Concerns have started to fade which has helped the EUR/USD find support at 1.2350-a former congestion area. Additionally, we have seen equity markets dip into positive territory which could be a supporting factor for the pair despite a decline in their correlation to 30% from 42% a week ago. The single currency found its footing at the end of last week as stocks were still being weighed by the prospect that a slowdown in the Economic Union would weigh on global growth. However, we can’t discount the relationship as the dollar continues to be a destination for safe-haven flows and continues weakness in either could drag the other lower. Meanwhile, interest rate expectations for the ECB have also ended their slide which has seen its relationship with the euro/dollar weaken as they have begun to flatten with the central bank expected to remain on hold for the foreseeable future.

PD-10-05-24-01

ECB Interest Rate Expectations

Overnight Index Swaps are pricing in 30 bps of tightening over the next twelve months which is up from 24.4 on 5/14 when we saw the height of the European debt crisis. Nevertheless, we see that yield expectations are significantly lower than the yearly average of 64.8 as the ECB is anticipated to be on hold until next year as growth expectations for the region have dimmed with the large cuts in government spending being put in place to bring runaway budget deficits under control. Therefore, inflation data and policy meetings may lose their market moving potential over the next few months as focus will be on activity and sentiment readings to determine the impact from the reduction in consumption. Discuss this and trading ideas join the EUR/USD forum.

PD-10-05-24-02

FOMC Interest Rate Expectations

The outlook for U.S, interest rates have dimmed further as the troubles in Europe are expected to increase policy maker’s apprehension in raising rates too soon. Fed funds futures are only pricing in a 21.4% chance of a rate hike in November with very little chance of tightening beginning beforehand. The expected improvements in durable goods orders and the second reading of first quarter GDP could improve the prospect of a rate hike if the U.S. economy continues to show signs of being able to withstand a slowdown from across the pond. Demand for long lasting items is forecasted to have increases by 1.3% in April, a sign that Americans remain optimistic. Meanwhile, the second reading of growth is expected to be revised higher to 3.5% from 3.2% as consumer spending was stronger than initially anticipated.

PD-10-05-24-03

Risk

Stock markets have consolidated following their sharp fall on the back of the heightened concerns over the impact of the European debt crisis on global growth. A strong existing home sales report showed that the sector remains firm but with the tax credit ending the next few months will be a better measuring stick of the sector’s health. Upcoming durable goods orders will be an important gauge for not only demand in the U.S. but the global economy as well. Global cyclical indicators have steadily improved and signs that the pattern is continuing will make the U.S. economy more resilient to broader weakness. A developing short-term triangle is pointing toward a breakout and at this pointy it is hard to tell what direction is favored, as an improvement U.S. fundamentals could spark optimism. Conversely, increased concerns that the troubles in Europe could eventually become a global issue could spark an extended flight to safety which could weigh on the EUR/USD. Discuss this and other fundamental data in the Economics Forum.

PD-10-05-24-04

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

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