The biggest story in the financial markets today was the 2% rise in the EUR/USD. The single currency experienced its strongest one- day rally this year and the move was driven by not one but five distinct factors:
1. Greek Debt Deal
2. Weaker US Data
3. Stronger Eurozone Data
4. GE-US Yield Spread
5. Speculative Positioning
First and foremost, the euro would not have experienced such a strong rally if not for the prospect of a deal between Greece and its creditors being announced as early as Wednesday. According to key officials, the EU and IMF have reached an initial agreement that would unlock additional bailout funds for Greece. The Eurogroup will review the document on Wednesday after which it will be handed over to Greece who needs to sign off on the terms but this last part won't come easily especially since the Greek government has submitted its own proposal. With the end of the month deadline looming, both sides are working quickly towards an agreement but more talks could be needed for a middle ground to be reached. This means that an official deal may not be announced until the end of the month with more back and forth between now until then. Unless progress is made every single day and the evidence of that makes the headlines the euro may find it difficult to extend its gains before an official agreement is made.
The EUR/USD also received support from stronger Eurozone and weaker US data. Consumer prices in the Eurozone grew at a faster pace, easing some of the central bank's concerns about low inflation. In contrast, US factory orders dropped 0.4%, which was more than expected and according to IBD/TIPP, economic optimism soured in the month of June. This divergence in data caused the yield spread to widen significantly in favor of the euro. While 10 year Treasury yields rose 8.5bp today, German bund yields of the same maturity rose 17.3bp. Recent changes to GE-US 10 year yield spread can be seen in the chart below. Finally, speculators continue to hold significant short EUR/USD positions and today's move triggered broad based short covering.
The next 24 hours is extremely important for EUR/USD. For Europe, there are revisions to Eurozone PMIs, an ECB meeting and consumer spending plus labor market numbers scheduled for release. The ECB is not expected to change monetary policy but the tone of Mario Draghi's press conference could have a significant impact on the currency. If he is optimistic, EUR/USD will break 1.12 but if he is cautious and concerned about downside risks, the currency will shed its gains quickly. U.S. fundamentals will also play a role in how EUR/USD trades as we have ADP, the trade balance, ISM non-manufacturing and the Beige Book report scheduled for release. The most important event risk for the dollar this week is non-farm payrolls and tomorrow's U.S. economic reports will help shape expectations for Friday's release. Strong job growth is essential to the resumption / continuation of the dollar's rally. Expectations are high for the labor market report and stronger service sector activity coupled with a rise in ADP are needed to push EUR/USD back to 1.10 and USD/JPY back to 125.00.
EUR/USD has broken above its 1.1050 resistance level but 1.12 may be difficult to break because as indicated in the following chart the 61.8% Fibonacci retracement of the 2000 to 2008 rally sits right above this level.
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