EUR/USD

Another successful bond auction from Portugal has the Euro extending its weeklong rally as easing concerns over the credit crisis turns the focus to interest rate expectations. Inflation above the ECB’s 2.0% target has policy makers on alert as they expect upside risks to continue in the short-term. The increasing prospect for a rate hike has seen yield expectations grow in importance in determining EUR/USD direction. The correlation between the pair and OIS strengthened to 39% from 19% a week ago, placing greater importance on the region’s fundamentals. As a result, risk trends have diminished in importance explaining 50% of movement compared to 62% a month ago. Nevertheless, broader sentiment remains the main driver and traders should monitor fourth quarter earnings to help gauge direction. The recent break from a month long range points to further Euro gains but a shift in sentiment could derail the prevailing bullish rally.

Driver of Price Action

Current Influence

Correlation

Week Ago

Month Ago

EUR Interest Rate Expectations

Medium

0.39

0.19

0.30

USD Interest Rate Expectations

Low

-0.11

-0.14

-0.14

Risk (Dow)

High

0.50

0.54

0.62

Euro_May_Remain_Supported_As_Easing_Debt_Concerns_Gives_Rise_to_Yield_Expectations_body_Picture_1.png, Euro May Remain Supported As Easing Debt Concerns Gives Rise to Yield Expectations

ECB Interest Rate Expectations

Euro-Zone interest rate expectations eased a bit today despite the strong Portuguese auction as comments from a German official raised some eye brows. Lars Feld an economic advisor to the German government forecasted that Greece will fail to pay its international debts without a cut and that German guarantees will be needed to restore confidence. The remarks are remaining markets that the bailouts of Greece and Ireland don’t guarantee that the worst is behind the indebt3eed nations and the possible of a broader contagion developing remains. Nevertheless, markets are still pricing in 65.3 bps in tightening over the next year from the ECB which only trails the BoC amongst the majors, which should remain supportive for the Euro. Discuss this and trading ideas join the EUR/USD forum.

FOMC Interest Rate Expectations

U.S. interest rate expectations continue to dim following a disappointing December housing starts report, as new construction drop 4.3% more than four times estimates for a 0.9% dip. However, a 16.7% jump in building permits could be a sign that the sector could be close to bottoming. The recent batch of U.S. data has been more in line with forecasts for a protracted recovery which has pushed out the horizon for a Fed rate hike. Markets are mow only pricing in a 4.0% chance of tightening by June which is down from 14.1% a month ago. Therefore, we may expect limited dollar support which could open the door for further EUR/USD appreciation if debt concerns remain in the background.

Risk

The lowest number of housing starts in a year overshadowed strong earnings from Apple and IBM and has stocks slightly lower on the day. Also adding weight is Goldman Sachs reporting a 53% drop in earnings despite beating estimates as expectations were starting to grow for a strong quarter for banks. Earnings season continues with several blue chip names let to report which could influence market sentiment over the next few weeks. The Dow failed to break above its upper channel bound which is increasing downside risks to 11,700 and could spell near-term EUR/USD weakness. Discuss this and other fundamental data in the Economics Forum.

Dow (1 Day)

Euro_May_Remain_Supported_As_Easing_Debt_Concerns_Gives_Rise_to_Yield_Expectations_body_Picture_4.png, Euro May Remain Supported As Easing Debt Concerns Gives Rise to Yield Expectations

Charts created using Strategy Trader– Prepared by John Rivera

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