The EUR/USD rose 1.6% within last three trading sessions and the relatively steep move higher of last two days tells the story of its hidden underlying strength. The upmove on EUR/USD was initiated by Thursday’s news of the ECB reading itself to revisit its monetary policy as early as this spring. Adding to the bullish move was the news of German political parties reaching the breakthrough agreement and opening the way for forming detailed coalition agreement. Backed by the news about the German politics the EUR/USD finally broke the resistance level at $1.2090 and rose to the highest level since December 2014 against the US Dollar with $1.2170 and then $1.2600 next targets.
With me working on this FX market for almost 20 years, I am sure that this is not a one-way ticket and the EUR/USD is going to face many hurdles on the way higher. My doubts, or contrarian views if you wish, are based on details of particular triggers of the upmove as well as based on a perception of a broader economic picture.
There is no mention of ECB revisiting policy in spring
The first reason for EUR/USD to jump higher was the ECB December meeting minutes. ECB accounts, as the minutes are officially called provided an extensive reading of details of views of the Government Council members of the economy and the monetary policy. While the move higher on EUR/USD was triggered by headlines of ECB revisiting its forward guidance strategy as early as in Q1 2018, I took the time to read the whole document and I couldn’t find it. I agree with headlines stating improved economic outlook for the Eurozone as a key fact behind ECB’s reduction of monthly asset purchases, but I doubt highly that this explicitly indicates that the monetary policy will be revisited by ECB this spring. There is no mention of anything like revisiting the monetary policy, or forward guidance in ECB’s minutes published yesterday.
My second source of doubts is the relativity of political stability. Main political parties in Germany are seeking the agreement on forming the government for months. While the first round of discussions with Greens and Liberals ended on ideological differences, Merkel’s CDU/CSU asked Social Democrats to join the government in the second round, ignoring the fact that they have previously ruled out any kind of government with her. Well, the grip to the power must be more fancy for SPD than their own conviction I guess. So far, so good… so what. The breakthrough agreement is now the new reality that spurred EUR/USD to jump to the highest level in 3-years. That, in fact, does not mean that Germany has a new government. The agreement between CDU/CSU and SPD warrant further political discussions on details of future cooperation only. As the devil is always in details, progressing further or deeper into the details of outlines for future coalition might be tricky with discussions ending as abruptly as the previous ones. I do not know enough details about German politics to claim the crash of political discussion between CDU/CSU and SPD, but I consider the promise of future agreement too fragile of a reason to justify such a massive FX market move.
Beware of inflation
The game changer in EUR/USD might come as early as this afternoon with the US CPI due. The inflation rate in the US is below the Federal Reserve’s target with officials trying to resolve the absent inflation puzzle for some time already. Nevertheless, the commodity prices are rising and should Canada serve as a proxy for the US (I know, I know that this is unlikely) inflation is going to pick up in the US as well. With the economic growth above 3%, higher commodity prices and severe winter conditions, the headline inflation is set to reappear. I know that the policymakers tend to look on core inflation and in case of Fed to the core inflation paid by households, but any sign of inflation rising on the horizon will be discounted in EUR/USD. Higher the inflation, tougher the straightforward move higher on EUR/USD.
ECB verbal intervention
Remember the times when the EUR/USD was trading above $1.2000 in last summer? Once the EUR/USD approached $1.2100 level, the ECB immediately intervened during the press conference. With help of ECB president Mario Draghi saying that the EUR/USD is too strong, the EUR/USD was sold down towards $1.1500. At the next ECB press conference due on January 25 I expect the same scenario to be repeated. I expect the ECB president Draghi to intervene against the strength of Euro during the next press conference in January. Reading the cautious tone of the ECB meeting minutes I doubt that policymakers will like strong EUR to choke the Eurozone's economic growth. I expect ECB’s voice to be loud.
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