'Drop in sovereign yields decreasing the demand for Euros' - Christopher Vecchio, DailyFX

Christopher
Vecchio

PROFILE:
• Current Job:  Currency Analyst for DailyFX.com in New York.
• Career: dual Bachelor of Arts degree in Government & Law and Economics from Lafayette College.

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Christopher Vecchio is a currency analyst for DailyFX.com. With a background in political science and law, he focuses on the interrelationships between geopolitical events, macroeconomic trends, and market reactions. Also an active trader, Christopher monitors the markets around the clock.

Many experts say that the EUR/USD correction is due to Grexit fears but others say that the EUR/USD advance is happening cause the Dollar weakness amid poor economic data, what do you think?

The Euro’s appeal, therefore, is rooted in the oversized short position currently in the market, which at least in context of EURUSD, could help propel covering in the very near-term (as was seen again this past week). As of March 14, there were 212.3K net-short contracts held by speculators in the futures market, off from 215.3K a week earlier (and down from the 226.6K seen during the week ended March 31, 2015). Otherwise, market participants are viewing the drop in Euro-Zone yields as a sign that the ECB will keep rates for an extended period of time, well-beyond the projected September 2016 finish for its QE program: the Morgan Stanley ‘months to first rate hike’ index currently resides at 56.5, suggesting a December 2019 or January 2020 rate hike at the earliest.

The drop in sovereign yields decreases the demand for Euros. With nominal yields falling and inflation expectations holding stable (and even slightly rising), real returns on fixed income investments are decreasing; in turn, this fuels demand for higher yielding/riskier EUR-denominated assets like equities; or forces Euro-Zone-based investors to look outside the region for opportunity – which means capital needs to be converted from Euros into foreign currencies. This is the “portfolio balancing channel” effect that ECB President Mario Draghi has been discussing since the beginning of the year.

What is your line in the sand to call for the end of the bearish EUR/USD days?

Price would need to clear out the post-FOMC swing highs above $1.1050 in order to end the current consolidation – a triangle relative to the March high/low and April high/low swing levels appears to be taking shape.

We saw a bunch of soft US data last week. Is this the definitive signal for a delay on the Fed rate hike?

For now, the data has translated into rate hike expectations being pushed back (as displayed by the federal funds futures contract). Market participants are pricing in the first Fed rate hike to come in December 2015; whereas Fed officials, as revealed in the March FOMC minutes, still believe that strong enough economic data could warrant a rate hike in June. Either way, there is a significant gap between what policymakers are saying and what markets believe; even if it closes halfway (say, to the market repricing a September rate hike), it could result in interest rate differentials moving favorably for the US Dollar.

The BoC stood pat last week, joining other central banks from Singapore, Australia and India that also kept their monetary policies stable in their meetings this month. Do you think the rate-cutting Currency War has ended?

No, especially for countries running current account deficits. Capital outflows in emerging markets is providing the tailwind for weakness in exchange rates, a situation that will only worsen as economic growth prospects weaken. Accordingly, in order to keep growth prospects boosted, emerging market central banks will be forced to keep policy loose (or looser), otherwise higher interest rates threaten to choke off diminishing growth rates entirely.

The oil prices jumped up after a bullish IEA report. Was that just a pullback or will we see a bullish trend extend?

Irrespective of the IEA report, crude oil has made a significant technical move: breaking above the $53.60/54.21 area. This zone served as support at the end of 2014 and solidified itself as resistance after numerous failed attempts throughout Q1’15. The recent break above through this zone opens the door for a potential broadening wedge bottoming pattern, which indicates the potential for a move into the low $60s over the coming weeks.