The EUR/USD has steadily risen throughout the past week outside some weakness today as it continues to see risk appetite dictate price action. Demand for higher yields is currently explaining 52% of volatility which is significantly higher from last week’s 39%.
The EUR/USD has steadily risen throughout the past week outside some weakness today as it continues to see risk appetite dictate price action. Demand for higher yields is currently explaining 52% of volatility which is significantly higher from last week’s 39%. Indeed, it isn’t a coincidence that equity markets are trading lower on the day following strength to start the week. Meanwhile, the ECB will decide on interest rates this week with policy makers expected to refrain from any actions. Interest rate expected to remain unchanged have minimized its impact on Euro sentiment. The central bank has been more concerned with the single currency’s strength and its impact on the region’s recovery. Therefore, we could see policy makers look to make supportive dollar comments which could negatively impact the pair. Conversely, U.S. interest rate expectations continue to have a negative correlation with the EUR/USD and the declining outlook for a Fed rate hike has helped support the pair.
ECB Interest Rate Expectations
Overnight index swaps are pricing in 81.6 bps of rate hikes for the ECB which is well above its six month average of 51.5. Despite the central bank’s efforts to temper market expectations, they are still very likely to begin tightening at the first sign of inflation. However, a rising Euro and lingering downside risks to growth will keep them on hold most likely through the first quarter of 2010. Indeed, second quarter GDP was revised lower to -0.2% from -0.1% due to a larger than expected decline in household spending, investment and exports. Policy makers could choose to focus on more timely data which has shown continued improvement including the PMI reading reaching its highest level since May, 2008, and German factory orders rising for a sixth straight month. Therefore, if we see a decidedly hawkish tone to post decision comments from President Trichet then yield expectations could soar driving the Euro higher.
FOMC Interest Rate Expectations
Fed funds futures are currently pricing in a 4.3% chance of a rate hike by the end of the year which is up from 0.0% yesterday which could be due to hawkish comments from Federal Reserve Bank of Kansas City President Thomas Hoenig. The FOMC alternate stated that the central bank should start raising rates sooner rather than later as “much time would pass before incremental increases could be considered tight or even neutral policy.” If U.S. interest rate expectations continue to rise, it could have a weighing effect on the EUR/USD. This could be the case as markets have started to price in an aggressive move by the Fed in January with a 1.4% chance of a 75 bps rate hike. If additional committee members begin to beat the drum for tightening then we could see the greenback find broad based support.
Equity markets have taken a breather today after consecutive days of gains. The Dow rose nearly 300 points at one point during the two day period. We are heading into earnings season and that could lead to a period of volatility for stock markets and the EUR/USD. Alcoa reports after the bell today and the first Dow component could set the tone for the season. Last quarter rebounding troubled banks led the headlines, this time the focus could shift to consumer related names as household spending remains a global concern, Next week names to watch will be Google, Johnson & Johnson, IBM, Southwest Airlines, Halliburton, GE, Citigroup, Goldman Sachs, Bank of America and JP Morgan.
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