EUR/USD: Gradual Or Glacial? A Buy On Dips Or A

EUR/USD: Gradual Or Glacial? A Buy On Dips Or A

EUR/USD is at crossroads: despite the slide, it is hesitating and lacking  conviction. What’s next? The team at Nordea checks out both options:

A special segment ahead of the big Brexit vote:

The Fed’s fears has gradually receded, prompting a surge in likelihood for a summer hike which has put the USD back on track (+3% in May).  A summer rate hike as well as markets glacial pricing of the Fed’s hiking cycle offer support for the USD, while we see no change in stance from ECB. Instead, ECB’s corporate QE and UK’s Purdah rules pose some downside risks to the pair in coming months.

The USD has reasserted itself strongly over the course of May, with the trade-weighted greenback set to see its strongest (3%) gain since the first month of 2015. The Fed’s fears, as we catalogued a month ago, has gradually receded, prompting a surge in likelihood for a summer rate hike.

While a Fed summer hike offers the USD some support from the policy divergence perspective, its December liftoff offered unknowns such as the “undiscountability” of the Death Star which its next hike does not – hence some tempering of optimism should be warranted.

Chart 1: The Fed vs the market

Federal Reserve against the markets

Even so, the market is pricing-in a rate hiking pace of merely one hike per year. This is not gradual, nor glacial (chart 1). It’s a geological rate hiking pace, and a far cry from what was often taken to mean gradual in 2015 (four hikes per year(*)). As long as economic data delivers and financial conditions does not tighten too rapidly (chart 2), this depressed pricing by itself offers support for the USD.

Chart 2: Financial conditions still very easy

financial conditions still very easy

On the other side of the Atlantic, we see  no near-term change to the ECB’s policies  even though it may be motivated to hike its growth and inflation forecasts somewhat. We continue to view  any talk of tapering as highly premature.

There are other factors potentially supportive of the USD (vs EUR) in coming months:  i) ECB:s commencement of corporate bond purchases, which could attract EUR issuance, depress basis swaps and weigh on the common currency,  ii) the UK’s Brexit vote  – remain sentiment could potentially face setbacks. UK’s  Purdah rules  will prevent civil servants and public officials from making announcements ahead of the referendum on June 23.  Communications momentum could start to favour the “leave” camp, which resides outside of the government (while mostly GBP-negative, we also think a  Brexit would be negative for EUR/USD).

Chart 3: Will PBoC care about the USD and will market care about CNY?

PBOC CNY USD measures June 2016

Finally,  China’s reaction to recent USD gains bears watching  as a higher USD/CNY has been at the centre of the last three major risk-off episodes (chart 3). If PBoC lets USD/CNY rise on the back of USD weakness it could pose risks to risk sentiment which could impact upon the Fed and consequently on the USD.

Chart 4: EUR/USD – at its post ECB QE1 average

EURUSD post ECB QE1 average

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Yohay Elam

Yohay Elam

Yohay Elam: Founder, Writer and Editor I have been into forex trading for over 5 years, and I share the experience that I have and the knowledge that I've accumulated. After taking a short course about forex. Like many forex traders, I've earned a significant share of my knowledge the hard way. Macroeconomics, the impact of news on the ever-moving currency markets and trading psychology have always fascinated me. Before founding Forex Crunch, I've worked as a programmer in various hi-tech companies. I have a B. Sc. in Computer Science from Ben Gurion University. Given this background, forex software has a relatively bigger share in the posts.