Euro’s 2017 rally entered into strong dilemma

The recent figures and fundamentals outline the dilemma facing the ECB. Even with the region's economy set for the fastest growth in a decade and the most broad-based expansion since 1997, a sustained price recovery remains some way off as unemployment unexpectedly fell but consumer-price growth missed estimates. The jobless rate slid to 8.8 percent in October, the lowest in almost nine years. Yet November inflation edged up to just 1.5 percent. Policy makers have acknowledged that this development warrants less additional monetary support, ECB President Mario Draghi has advocated a "patient and persistent" approach to exiting the central bank's stimulus program. Stronger recovery and monetary stimulus are making national debt burdens more sustainable, though the risk remains that political uncertainty could cause yields to spike abruptly.

Peripheral euro-area bonds have drawn strength from reducing political risks. Tensions between Spain's errant Catalonia region and the central government in Madrid have cooled, while in Italy, the passing of an electoral reform has made it less likely the anti-establishment Five Star Movement will enter government. Diminishing tail-risk of a euro-zone breakup combined with ECB's stimulus extension made market bullish on peripheral bonds. As outlook is brightening, markets aren't pricing in even a 10-basis point interest-rate increase until at least October 2019.

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Apart from fundamentals and strong recovery under lower inflation, Euro is likely to get support from foggy US fundamentals and uncertainty over tax bills. Here is some mixture of US, European rate and spreads which might clear short term pictures.

1. Ted spread:-

The TED Spread is the difference between the 3 month T-bill rate and the 3 month London Inter Bank Offered Rate (LIBOR). It is important because it is an indicator of perceived economic risk, monetary liquidity, and perceived credit risk of the global financial banking system. A rising or high TED spread indicates increasing risk of bank defaults and economic instability. Below chart suggests that Ted spread is leading indicator for EURUSD. Currently, Ted is moving higher (spread is narrowing down) and this suggests bullishness in Euro.

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2. COT Report (CFTC- Net non-commercial position):-

The Net Non-Commercial Positions shown in the chart above are from contracts held by large speculators, mainly hedge funds and banks trading currency futures for speculation purposes. Below chart suggests that they are holding their position at multiyear high despite correction and followed by consolidation move in the Euro. This suggests upside potential in the euro.

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3. German-US 10 year Bond Yield Spread:-

It is observed that German-US 10 year bond yield spread is leading indicator for the Euro. However, correlation in November is broken as pair advance above 1.1900 but spread remained flat. This could create doubt regarding euro's stability against US dollar.

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