As the start of the Asset Quality Review (AQR) approaches, the shares of Euro Area financial institutions will become a more important variable to watch as a guide to intraday ranges in EUR/USD. Better financial conditions mean higher asset prices, and higher asset prices mean greater capital inflows – and hence, a stronger EUR. Of course, the flipside of this feedback loop is that further capital raising and/or balance sheet shrinkage will initially tend to hurt the EUR, and make the price more vulnerable to slippage of varying degrees.
For the time being watch the 137.50 level in the Euro Stoxx Banks Index, which is the 23-October low following the ‘rejection’ of the recent cyclical high just above the 142.00 mark. To qualify things further, the cyclical high in the Index was where we ‘maxed out’ prior to the ‘unofficial start’ of the AQR, which we can probably assume was marked by Draghi’s remarks yesterday afternoon. A break and/or close below the 137.50 level in the Index should restrain EUR topside. However, please be mindful of the fact that the ‘EUR/USD to $1.40 and beyond movement’ is still of the mindset to ‘reload’ for additional attempts at new cyclical highs in the pair following brief spells of EUR downside. We suspect that there are a lot of bids between 1.3700 and 1.3750 right now.
The complicating factor for Euro Area policy makers wishing for a softer EUR during this cycle is the impact of QE3. The strength of the programme raises the hurdle news and other events need to ‘jump’ in order to actually weigh on the currency – and drag the banks down first. We think the best chance the EUR has to sustain downside is for AQR difficulties to coincide with a Fed taper, but we seem to be a very long way from there right now.
BMO