Euro has potential for a bullish breakout

Capital flows into high yielders as Fed prepared to hike rates
by Ipek Ozkardeskaya

Risk sentiment is rather good at the start of this year’s last Fed-focus-week. The Fed is expected to take the first step toward policy normalisation on Wednesday and the market is presently pricing in a strong 74% probability for a 25 basis point hike. This is slightly lower than last week’s assessment of 78/80% probability. Nevertheless, it appears that the FOMC is given little margin to steer.

This being said, the global macro-economic picture has totally failed to provide a comfortable setting for the first rate hike. The inflation forecast has taken its toll last week on the heel of the renewed rout in commodity and energy prices. The pitiless slide continued in Asia as crude oil prices were tossed down to fresh seven-year lows; WTI slid to $35.27 in Asia, as Brent bottomed at $37.44. Natural gas fell to its lowest intraday level since 2002.

This is why we see little chance for FOMC Chair Yellen to simply hike the rate and walk out. Any potential rate rise is expected to come along with a fairly dovish accompanying statement regrading the pace of the normalisation.

Henceforth, the global deflationary pressures and the growing downside risks related to cheapening oil prices could regulate the slope of the Fed rate tightening. Janet Yellen may pronounce the magic formula: that policy normalisation is not on a pre-set course and the macro-economic data will be watched closely. Data dependency will still be first and foremost.

The Eurozone sovereign market is under a decent selling pressure this Monday; with the euro paring gains versus the US dollar and the pound. The European equity market has made a flat opening to the week with the FTSE so far unable to make a break above the 6000 level despite the oversold conditions.

The capital flows into Asian bonds, with Australian and New Zealand bonds benefiting the most from this carry traffic. The fact that the Fed rate hike is almost considered as warranted and is broadly priced in, the carry traders seem to be moving back to their yield hunting journey.

The abnormally low Eurozone rates are pushing investors to chase a better return elsewhere, and now that the Fed rate hike risk is mainly priced in, there is a growing appetite in capturing the rate differential.

This is a sign that a good chunk of the market expecta a potential squeeze in the US dollar short positions following a rate hike.

Euro has potential for a bullish breakout

EURUSD traded below 1.10 in Asia, yet the IMM data showed little appetite in non-commercial EUR short positions since the decent euro rally we witnessed post-Draghi. Given the deeply sold euro, there is a room for decent upside should the potential Fed rate hike lead to a buy-the-rumour/sell-the-fact squeeze in USD long positions.

The 200-day moving average (1.1033) is expected to be a solid resistance before the Fed decision. The formation of a bearish belt hold line has warned of the exhaustion of the uptrend last Friday, suggesting a setback to 1.090 and even 1.0845 (major 38.2% retrace on post-Draghi surge). Above 1.0845, the short-term bias is still on the upside. If the 200-day moving average is surpassed, the EURUSD could well stretch higher toward the key mid-term resistance eyed at 1.1268 (major Fib 38.2% retrace on Dec’14 – Mar’15 decline). The mid/long-term view remains bearish.