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EURUSD Rally Beset by Stimulus Competition, Depends on Risk Trends

EURUSD Rally Beset by Stimulus Competition, Depends on Risk Trends

John Kicklighter, Chief Strategist

Dow, Nasdaq 100, Bitcoin, EURUSD and USDJPY Talking Points:

  • US indices were broadly higher with the Dow, S&P 500 and Russell 2000 all notching record highs while other assets trading during NY hours bounced
  • An ECB commitment to bolster stimulus spoke to the market’s appetites while Biden’s signing the $1.9 tln stimulus program added to enthusiasm
  • Notably, EURUSD rallied the past session but USDJPY held steady which suggests the risk trends may play a more prominent role in Dollar and market movement than stimulus
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The Dow Leads US Indices to Record Highs, Enthusiasm Continues to Outrun Concerns

The fundamental waves continued to rise for risk appetite this past session, and speculative benchmarks like the major US indices seemed more than willing to take advantage of the situation. In contrast to the relative improvement of conditions with a temperate US inflation figure on Wednesday, this past session’s ECB commitment to upgrade its stimulus efforts while President Biden signed the massive $1.9 trillion stimulus program into law were firm steps for confidence…and likely growth. Taking stock of the optimism, the blue-chip Dow Jones Industrial Average advanced to a fresh record high with trader favorite S&P 500 and broad small cap Russell 2000 topping their charts as well. With a range of carry, commodities, emerging markets and high-yield fixed income all in step during New York trade; bulls looking for a reason were more than satisfied.

Chart of DIA Dow Jones ETF and NDX-Dow Ratio with Volume (Daily)

Chart Created on Tradingview Platform

Yet, as uniform as the move may have seen in the typical measures of speculative appetite I follow, there are some holes in conviction. The tech-heavy Nasdaq 100 did advance on the day but remains well off last month’s record. Further, the clip of advance for those markets that did breach to new altitudes was notably lackluster. Furthermore, there was some notable disconnect between similar assets that would normally enjoy the tail wind together. An example was the restraint on the UK’s FTSE 100 while the German DAX extended its record run. What is the difference: fresh stimulus for the Eurozone but not for the UK. Local infusions of external support seem to be a factor in recent performance, but standing on the speculative scale seemed to be another factor. An example of that is Bitcoin which pushed to a fresh record high through Thursday’s close on the back of a 7-day run. Then again, GameStop and Dogecoin were treading water; so preferences are definitely being fleshed out.

Chart of Bitcoin with Consecutive Daily Candles Overlaid with the Dow (Daily)

Chart Created on Tradingview Platform

Stimulus Plays Drags the Markets On a Ride

One of the more notable fundamental focal points this past session was EURUSD. Technically, the pair rallied back above 1.1950 which was one of the notable technical floors taken out in the tumble of the past two weeks. If this were all the information we had to go on, it would look like a solid turn above a 200-day moving average with enough vigor to take out new resistance. However, I believe this was a well-timed confluence of events that will struggle to carry markets forward without further encouragement.

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Chart of EURUSD with 100 and 200-Day Moving Averages (Daily)

Chart Created on Tradingview Platform

The top scheduled event risk from this past session was the European Central Bank’s rate decision and updated economic projections. The group did upgrade its growth outlook for 2021 (from 3.9 to 4.0 percent), but the real interest was in the news that they would “significantly” increase their bond purchasing efforts. An upgrade in stimulus is no small thing for these markets, but there is ambiguity as to the volume. Exactly how much additional support the central bank will add per month was left purposefully vague to let the market’s imagination to stretch optimism – and to prevent the perception that they are operating outside of their mandate to keep yields low. Expectations of supported economic growth and easing the recent surge in European yields does bolster risk trends, but that doesn’t necessarily set the stage for a Euro rally. In fact, outside of EURUSD where the Dollar was under more pressure and EURJPY where ‘risk on’ was top influence, the currency struggled.

Chart of Major Central Bank Balance Sheets in US Dollars (Monthly)

Chart Created by John Kicklighter with Data from Federal Reserve Economic Database

If the day’s EURUSD charge wasn’t the result of a strong Euro move, then it would stand to reason that the Greenback was taking a significant hit. That would bear out. Top news out of the US was Biden’s pushing the long-awaited $1.9 trillion stimulus follow up (dubbed the American Rescue Plan Act of 2021), which alongside the President’s commitment to have make available vaccines to all American adults by May 1st, would seem to bode very well for intermediate growth forecasts. And yet, the Greenback slid. If this is in response to a slip in US Treasury yields as a carry appeal, I believe the Dollar drop could stall quickly. US yields held up well relative to the European entrenchment. If US yields start rising again, the Dollar can draw relative benefit. Yet, if this country’s rates start rising – no doubt with inflation concerns in tow – it is likely to take global yields along for the ride.

Chart of DXY Dollar Index and Ratio of US 10-Year to Aggregate Global Yield (Daily)

Chart Created on Tradingview Platform

Stubbornly-high yields bring another important aspect to the table: risk trends. Another Dollar pair to unwind this past session’s motivations and what it means for Friday and beyond was USDJPY. If the US currency was indeed under serious pressure, this pair would have dropped as well. In fact, it advanced. That suggests that the ‘risk-on’ as the other substantial fundamental theme beyond the pair carried more weight. If the Dollar is losing altitude to the likes of the Euro owing to a safe haven premium being worked off, that is not likely a trend to run very far. Though the ECB’s fresh commitment, new funds from the US government and even the Fed’s 4Q household wealth report signaling a record high are encouraging; they have been expected and are likely saturated.

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Chart of USDJPY with 200-Day Moving Average (Daily)

Chart Created on Tradingview Platform

If markets are already discounting the newest rounds of support and the upgraded forecasts for reopening the economy, overindulged bulls will look for something more to further their already bloated appetites. Instead, the risks are standing more prominent. Favorable growth forecasts are bringing inflation expectations which undermine the perception of a limitless central bank safety net. In turn, yields are holding elevated either through growth optimism or inflation fears – and a cautions market will read into its explanation. What’s more, the same conditions seem to be further fueling rumors that the Fed is preparing to shift its ‘dot plot’ for to bring forward normalization while the BOJ is said to be considering scraping its ETF purchases. Don’t bank on risk trends to simply run because the Dow hit a new high. By the same token, don’t presume the Dollar is simply going to tumble to and below 90.

Chart of US 10-Year Treasury Yield Overlaid with Dow (Daily)

Chart Created on Tradingview Platform

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

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