The euro spiked higher versus the dollar and on the crosses Thursday, despite the release of German data earlier, showing lower-than-expected inflation and despite market jitters about Friday’s release of flash EMU inflation data.
Traders viewed the rebound, back above $1.3700, as largely an unwind of short-term euro short positions.
“It’s a short squeeze – that’s what it is; the euro is overvalued up here,” said one U.S. trader.
Preliminary German inflation data, released earlier, showed that consumer prices rose 0.5% on the month, and increased 1.2% on the year. Analysts had expected 0.6% m/m and 1.3% y/y, according to the median in MNI’s survey.
HICP figures showed a 0.5% rise on the month and annual inflation at +1.0%, also undercutting analysts who had expected 0.7% m/m and a rise to 1.1% on the year.
Germany’s inflation data may point to a lower reading for flash EMU inflation, which is set for release Friday. MNI’s weekly survey forecasts a change of 0.7% for Eurozone HICP.
Traders sold euros aggressively in response to the flash German inflation data, only to regret their decision later.
The market remained bearish towards the euro, still thinking that the European Central Bank might take action next week, and that the eurozone economy will likely still underperform the U.S. economy going forward.
“Eurozone disinflation intensifies and real economic data has disappointed of late,” said G-10 strategists at CitiFX.
“As a result, ahead of the ECB a growing number of banks, including Citi, are calling for a 10-15 basis point main refi rate cut and unchanged deposit rate in March or April,” they said.
The market is already pricing in about 4 basis points of cuts, suggesting a bit less than a 50% change of a 10 basis point refi rate cut.
The market also looked for the ECB’s updated staff projections “to highlight that inflation is expected to remain below ECB’s target for a very long period of time” and “for more clarity on the sterilization of SMP,” the strategists said.
“If the ECB cut rates next week and temporarily suspends SMP sterilization (making it more QE-like) this could keep EUR under pressure against G10 majors, at least temporarily,” they said.
The euro “could be more resilient against risk-correlated currencies,” if risk sentiment deteriorates further from here, CitiFX added.
An “undoubtedly subdued inflationary environment” may not be enough to prompt ECB action next week, said RBC Capital Market strategists.
“The narrative” from the updated ECB staff forecasts “will very likely be one of sluggish inflationary momentum, but we think it will stop short of any suggestion that longer-term inflation expectations are becoming unhinged to the downside,” they said.
“As such, we think it is too early for serious discussions on QE-type interventions, even if the ECB will keep such ideas alive,” the strategists said.
ECB action, if seen, is more likely to be on the liquidity front, they said.
Eurozone money markets have been becalmed recently, compared to that seen earlier in the year, but the ECB “may still want to put soothing measures in place,” RBCCM said.
“That may come in the form of a refi rate cut, as has been our call since January,” they said.
“However, other options, including a pause to sterilization of SMP purchases, are gathering steam, and that may be a sufficient sticking plaster for now,” the strategists said.
Jitters about Friday’s flash EMU inflation data, as well as next week’s ECB decision has the market leaning bearish towards the euro.
The euro was trading at $1.3713 Thursday afternoon, on the high side of the day’s range of $1.3643 to $1.3727.
Earlier, ahead of the German flash inflation data but after the states of Saxony, Bavaria and Hess reported), the pair fell below its 55-day moving average (at $1.3659 currently) to post a two-week low of $1.3643 and revisited that area after the large EMU release.
In a “buy the rumor, sell the fact” move, the euro edged higher ahead of the U.S. open, and rose further as U.S. Treasury yields began to fall.
The euro faces tough resistance in the $1.3765/75 zone, an area of several highs from earlier in February and also the 2014 high near $1.3775, seen January 2.
A clear-cut break above $1.3775 would suggest scope for a return to the 2013 highs near $1.3893, seen December 27.
Conversely, a move and close back below the 55-day moving average would suggest that the downtrend has legs, with initial support seen at $1.3585 and $$1.3562 (Feb 13 and Feb 12 lows), ahead of larger support at $1.3475/$1.3485, the late January/early February lows.
The euro was also firm versus most crosses, especially versus the Russian ruble and Ukraine Hryvnia, which hit new life-time highs at Rub49.5785 and Uah15.5240 earlier.
Earlier also, ten-year German Bund yields (1.561% currently) hit a low of 1.545%, the lowest levels since last July.
In addition, European periphery 10-year bond yields traded sharply lower Thursday, with Italian 10-year yield below 3.50%, the first time since start if 2006, supported by strong new 10-year BTP auction. Greek 10-year bond yields are below 7% for the first time since April 2010.