Euro Breaks Above 1.2000 for First Time in 2.5 Years

The Euro continued its rally last Friday after ECB President Draghi failed to talk down the Euro’s rise during his speech at the Jackson Hole symposium, sparking hopes that interest rate increases are just around the corner. The single currency gained considerable traction against the dollar as the Fed’s Chair Yellen, did not mention monetary policy during her speech, leading to opinions there may be little room for further hikes this year.

The central bankers’ comments drove the EURUSD from its close on Thursday at 1.17991 to reach a most recent high yesterday at 1.2070, a level not seen since January 2015. However, yesterday’s close below 1.2000 signals a weakness which may be indication for lower prices as the market takes a breather and gathers more strength.

The Euro had suffered greatly from the geopolitical risk of the French election which may have seen an anti-EU president as head of state. Coming so shortly after the UK referendum to leave the EU, the local currency was under a lot of stress. The narrative changed with the French election giving a pro-Europe President, his election was parallel to the Fed changing its stance on monetary policy tightening, leaving room for fewer interest rate hikes than initially forecast.

Economic data to be released this week include; Euro area Consumer Price Index (CPI) and Non-Farm Payrolls (NFP). Both are important to the respective central banks when determining monetary policy. Euro CPI will be released Thursday at 10 am, forecast is an increase of 1.4% YoY after last month’s reading of 1.3%. NFP will be released at 01:30 pm on Friday, forecast is for an additional 180k jobs, after last month saw 209k new jobs.

Inflation data and job creation have both been used by the ECB and the Fed when determining monetary policy. Both currencies have seen a small reduction in the rate of inflation, mainly due to energy price decreases. Which has caused the Fed and ECB to be more cautious on further interest rate hikes this year.

Both central banks are dealing with implementing balance sheet reductions in the near future. The ECB is reluctant to even mention when it might start the process of reducing its bond holdings, in fear of creating a bond sell-off. The Fed is also in the same position but has clearly stated that the US central bank will start holding less bonds very soon and that the process will be implemented prudently so as not to disrupt the markets.

In either case, the central banks are likely to start running down their balances simultaneously, as not doing so would create a large imbalance in either currency. The central bank that starts long before the other, should see its monetary mass expand and its currency depreciate, unless it also raises interest rates. The next ECB policy meeting is September 9th and should give some more clues about balance reduction a monetary tightening.