FX market players maintained a bearish bent towards the euro, but were wary nevertheless of holding a euro short position heading into Friday’s release of key eurozone inflation data and next Thursday’s European Central Bank decision.
While unlikely, flash HICP data for August could come in stronger than expected, traders said.
The ECB may announce new easing measures at next week’s meeting, or may yet again disappoint, as the central bank has also made it clear that it wants to see the full effects of the June easing before trying something else, they said.
The euro was trading at $1.3200 Wednesday afternoon, in the middle of a $1.3153 to $1.3210 range.
The earlier euro low was the lowest level seen since Sept. 6, 2013, when the pair bottomed at $1.3105, now seen as the next level of support.
From the 2014 high of $1.3993, seen May 8 to today’s lows, the euro was off 6.0% and from the July 1 peaks at $1.3700, seen after the ECB announced a variety of easing steps June 5, the euro was off 4.0%.
With interest rate differentials between the U.S. and eurozone expected to diverge further going forward, the FX market looked for further euro declines to $1.3000, and potentially even $1.2500.
It would take a move back over the early August lows in the $1.3330 to $1.3340 range before the market would become even slightly euro bullish, traders said.
And even in the case of a massive euro short squeeze, which is not out of the question given the sizable speculative net euro short positions in place, market players would sell any rally in the $1.3400-$1.3500 zone, they said.
This week, Nomura strategists outlined three factors that have been driving the eurozone outlook, i.e. ECB President Draghi’s Jackson Hole comments, deemed dovish, eurozone equity and bond flows, and Ukraine-Russia tensions, which pose “a downside risk to the eurozone economy.”
“All these forces are negative. In addition, the news we have received from the U.S. side, including a substantially more balanced Janet Yellen on Friday, also poses additional downside risk for EURUSD,” they said in a note.
“In particular, we think there is substantially increased chance that the September FOMC statement will see a material change, and amount to a meaningfully revised signal from the Fed,” they said.
This would underpin the dollar overall versus other global currencies and likely lead to further downside pressure on the euro in the near-term, the strategists said.
“All told, these forces could see EURUSD test 1.30 in fairly short order, especially if the Fed really delivers a new signal on September 17,” they said.
Nomura saw scope for the euro to move away from the “grinding lower” movements seen recently, toward a more fast-paced move lower in the coming month.
“The risk to these basic views is that some catalyst ignites an unwinding of existing EUR shorts, which have been building rapidly in recent weeks,” the strategists said.
“But without a specific catalyst lined up, we don’t want positioning alone to make us shy away from downside strategies,” they said.
German Bund yields have fallen at a steady pace in recent weeks, and while U.S. Treasury yields have been dragged lower also, interest rate differentials are at the widest in favor of the dollar in over a year.
Ten-year German Bund yields, last around 0.908%, were up from the record low of 0.8951% posted earlier Wednesday.
Lynnden Branigan, technical analyst at Barclays, saw 0.89% as the next big technical support level for 10-year Bunds, with additional support at 0.72% on the monthly chart.
Yield supports “become somewhat scarce when we are in new territory,” he said.
As for the yield differentials, “German bond outperformance relative to U.S. counterparts points to further widening toward targets of -72 basis points in the 2-year tenor and -154 basis points for the 10-year German-U.S. yield spread,” Branigan said.
The 10-year German-U.S. yield spread is currently around 145 basis points.
Friday’s release of flash HICP and core CPI data for August presents event risk for the euro and eurozone yields.
Economist’s median estimate for August is +0.3% year-on-year for flash HICP and +0.8% year-on-year core flash core CPI. This compares to +0.4% and +0.8% in July.
If inflation somehow surprises to the upside, eurozone yields, and the euro, would likely see a correction higher.
Credit Suisse strategists looked for this Friday’s data to show that eurozone inflation dropped from 0.4% year-on-year in July to 0.2% in August. Beyond that, they saw inflation troughing at 0.2% year-on-year in September.
“This is likely to be driven by decreasing oil prices, which have fallen by 4.7% in the past month,” they said.
In addition, “food inflation is expected to continue the weakness seen in the past few months, especially in light of the Russian ban on food imports from the euro area,” the strategists said.
Credit Suisse assumed the ECB will be “keen to see how inflation expectations evolve as activity picks up and there has been some increase in inflation swaps, particularly for shorter maturities, since the Jackson Hole speech.”
“Similarly, while confidence indicators have clearly been impacted, it remains too early to evaluate how negative an economic impact geopolitical developments will have had,” they said.
The strategists stressed that while “Draghi has upped the ante ahead of next week’s meeting” and financial market are pricing in new easing measures, “it would seem rather early to launch a meaningful new stimulus programme, particularly just ahead of the first TLTRO in mid-September and the AQR results in October.”
“More likely will be an increase in the rhetoric – regarding what has already been announced, and of course the potential to do more if needed,” Credit Suisse said.