Why Is EUR/USD So Stubbornly Strong?

Market Drivers July 14, 2014
NZD Performance improves across the board
Equities lead high beta FX higher
Nikkei 0.88% Europe 0.55%
Oil $100/bbl
Gold $1321/oz.

Europe and Asia:
NZD Performance 54.7 vs. 54.1
JPY Industrial Production 1.0% vs. 0.8%
EUR Industrial Production -1.1% vs. -1.2%

North America:
CAD HPI 9:00 AM

High beta currencies and yen crosses rose slightly at the start of the week's trade boosted by better equity indices with both Nikkei and Eurostoxx 50 rising in morning London trade. The Nikkei gained 0.88% while Eurostoxx was up 0.81% as investor sentiment remained positive.

There was very little on the calendar today with only smattering of information out of Asia where the New Zealand Performance Services rose to 54.7 from 54.1 the month prior. All five main sub-indices were in expansion territory with employment subcomponent rising to 52.4. Although Westpac lowered the milk payment forecast for New Zealand for 2015, the market still anticipates steady growth for the country's economy in H2 of this year and all eyes will be focused on the RBNZ decision later this month to see if the central bank chooses to tighten further, although consensus is forecasting no change out of RBNZ. The kiwi remained steady above the .8800 throughout Asian and European dealing.

In Europe the only report of note was the EZ Industrial Production numbers which declined by -1.1%. This was slightly better than the forecast of -1,2% contraction but nevertheless showed a clear slowdown in the region manufacturing growth that is likely to be a drag on growth in Q2 of this year.

The news knocked EUR/USD off the session highs but the pair remained firmly bid above the 1.3600 level. Many analysts have wondered why the euro has not fallen further against the greenback given the lackluster economic conditions in the region and the answer appears to be twofold. The surprising decline in US long term rates with the benchmark 10 year still trading near the 2.50% yield level has provided little reason for speculators to establish aggressive dollar longs for the time being. However, perhaps the biggest reason for euro strength has been reserve diversification especially by the PBOC which may be the unexpected buyer of euro in the market.

In either case the euro has held steady above the key 1,3500 level and will likely not weaken until one or both of these dynamics begin to change. To that end, this week's testimony by Janet Yellen could be key to the greenback movements. Ms. Yellen has been a staunch dove, suggesting that rates are likely to remain at the current level until well into 2015. However, this weekend's article by Jon Hilsenrath of the Wall Street Journal suggests that some FOMC members are beginning to warm up to the idea of an earlier timetable for a rate hike given the better than expected US employment picture. If Ms. Yellen echoes those sentiments in her testimony this week, the EUR/USD could see another leg down as US rates respond accordingly.