A Shot Across the Bow for the EUR Bull

Draghi’s Crying Call Supports QE trades

Euro Session Looking To Reestablish EUR Shorts

Bunds and Treasury’s Yields Capped For Now

Market Looks To Commodity Currencies For A flutter

George Soros’s Quantum fund did take on the Bank of England and broke it on what is known as Black Wednesday in 1992, but in general, investors should be wary of taking on a central bank. Historically, they have more ammo than the market.

Yesterday, European Central Bank (ECB) President Mario Draghi slowly put his foot on the brakes, temporarily capping the EUR’s May rise by reiterating that the ECB’s vast stimulus efforts will remain in place “as long as needed.” Or at least until ECB officials are confident that they will meet inflation objectives on a sustained basis.

Lately, both dealers and investors have bet the recent string of moderately upbeat European data will prompt the ECB to pull the plug on its quantitative easing program before September 2016. The ECB targets annual inflation near +2%, and the reality is that consumer prices were flat in the eurozone last month on an annual basis, and have been negative for several months before that. So there is no hurry.

What’s important is that the monetary efforts are sustainable, growth is sustainable, and with that, sustained inflation. To get to these continuous levels requires the ECB to maintain a lower finance cost for investors and a lower cost of borrowing for consumers. The recent sovereign bond rout that has led to ballooning yields only hampers the ECB’s efforts.

Forex Relies on Bund Yields

There are tentative signs that the recent rout in bonds is easing and that the strong correlation between yields and the EUR’s direction remains intact. All week technical analysts have been trying to keep up with some of the extreme moves across the currency pairs, plotting next resistance levels as the “long” dollar squeeze prevailed. Now it seems that Europe is happy to contemplate as to where to short the EUR believing the divergence theme between the ECB and FED would likely rise again – this should allow QE trades to find firmer footing especially after Draghi’s comments yesterday. Already the German 10-year Bund yield is lower by over -7bps to test below +0.64%, which is allowing the EUR bear to close out the week leaning on the single currency.

It seems that short covering from day trading types and short-term model driven accounts is helping push the bid in Bunds as futures lead the price action. Europe is simply trying to catch up to the rallies in Treasuries and JGB’s seen yesterday.

Nevertheless, Draghi’s QE crying call is being used to change mid-bond traders mindset. They are naturally flattening (-2.5bp to 81bp since yesterday) the belly of the bund curve (2/10’s) and a sure sign to some that rate divergence is very much in play again. Individually, 10-year Bunds are capped by +0.80% at the moment but remain a danger, while 10-year Treasury’s has managed a decent recovery from +2.365% high point this week (last at +2.19%). However, be aware that a lack of liquidity in fixed income market remain an issue and could exaggerate some of the moves as some traders take an extended Ascension holiday.

Markets Eye Commodity Currencies For a Flutter

Investors are finally willing to look more closely at commodity and interest rate currencies like the Aussie, Kiwi and Canadian dollar. Of late, they have been outperforming the “mighty” dollar by some degree (loonie trading C$1.1930, AUD breaching A$0.8140 and the NZD printing $0.7550) and in direct conflict to their respective Central Banks rhetoric. The recent strength by commodity currencies is showing signs of reversing, with topping chart patterns in AUD and NZD outright, while USD/CAD shows signs of basing.

The RBA’s Governor Stevens has been taking any opportunity to talk down his currency. This week’s Aussie budget (more a political rather than economic showing) allowed the Aussie to find firmer footing. Pushing the AUD to new heights was Fitch ratings stating that there was little evidence to suggest Australia’s AAA sovereign rating would come under threat. Nevertheless, China (Australia’s largest trading partner) will be the AUD undoing in the medium to long term as soft data continues to challenge China’s desired +7% growth rate.

The CAD’s meteoric rise has been supported by the stabilizing prices in oil. Since the middle of April, crude prices are up +45% from their one-year lows. But, with +60% of that rise due to a reduction in production and not growth expectations (global first-quarter growth is projected to be +1.2%, the lowest in 25 years) will eventually hinder the CAD progress. The demise of the USD has obviously supported pushing energy prices higher, and there are tentative signs that the dollars rout has been stretch enough. CAD bears remain better buyer of USD on dips, looking for some dollar relief towards C$1.2250.

The NZD has been rather active all week and has taken another small hit in overnight trading after dairy co-operative Fonterra (sets world dairy prices) announced an unexpected cut in production volume forecast. This coupled with fixed income traders pricing in a -50bp RBNZ OCR cut by year-end has dented most bull’s bias for a higher NZD. Through NZD$0.7360 the bears will be looking to target the 2015 low of NZD$0.7175.