A long pause or the end of the USD rally?
A strong non-farm payrolls number, an optimistic outlook for the US economy, reflected in soaring share prices, and higher US interest rate expectations simply don’t seem to be moving the dial for USD. Does this mean that all these factors are fully baked into the markets, implying little upside potential for the greenback?
The markets are expecting three rate hikes this year with one of them due to happen on Wednesday following the Federal Reserve’s FOMC meeting. The data so far has done little to meaningfully shift those expectations – though this could be influenced by the FOMC statement and US inflation numbers due to be released on the same day.
This has helped keep EURUSD above the crucial parity level as the EU faces the possibility of electoral upsets driven by populist parties and the ECB is still doing quantitative easing.
February’s non-farm payrolls number of 235,000 was certainly a strong, better than expectations for 200,000 and similar to January’s number of 238,000. Dig a bit deeper into the figures and the market was disappointed to find that wages had only increased 0.2% versus 0.3% the month before. One potential source of inflation, which could drive more US interest rate hikes than expected is therefore looking muted for the moment.
But there’s another possible explanation behind USD’s stubborn refusal to rally. US bond yields have risen significantly since November 2016 and they impact the cost of finance to the rest of the economy. Mortgage rates are rising, for example, and more worrying, losses on US subprime car loans are at their highest levels since the 2007-9 financial crisis, and this is pushing up the cost of finance for buying cars.
At the same time, parts of the bond yield curve are flattening suggesting that the bond market is becoming less optimistic over US growth prospects – possibly due to the rising cost of money, coupled with weak wage growth and higher inflation, which will erode consumer purchasing power.
On the other side of the equation there are also some important European developments to consider. Moving away from the scary scenarios around a populist election victory, there are some positives for the Eurozone – it’s actually growing at its fastest pace in years and it is broadly based. And there’s more. Inflation has made a return to the Eurozone leading to ECB President Mario Draghi to declare a victory against deflation – a big source of concern for several years.
This clears the path for the ECB to taper its quantitative easing programme sooner than anticipated. It has been key to reviving the Eurozone economy, but if it is removed that does raise concerns over some peripheral country bond yields.
However, there’s a real chance that EURUSD could actually rally, particularly if the populist parties lose traction at or before elections in the Netherlands (this month) and France (next month and likely again in May) and Italy (sometime before June 2018). Germany’s September election so far looks the least likely to produce a surprise result.
Though it’s by no means certain – there’s a possibility that for this year at least, the USD rally has run out of steam, and if the Eurozone can avoid a big electoral upset, which still seems likely, then it could be the EUR making upside as it appears to have more potential to surprise on the upside than USD at the moment.
TECHNICAL ANALYSIS: EURUSD looking more positive
The EUR has been steadily working its way higher since January when support levels around 1.0300 to USD managed to hold and following a recent dip, where support levels around 1.0500 held out. It appears that a case for a EUR rally might be building.
The next target for EUR/USD would likely be around 1.1000, last seen in November 2016. A dovish or neutral FOMC statement this week or an election victory by a coalition of moderate parties in the Dutch elections could be catalysts helping EURUSD on its way. In the short-term a small pull back is likely before building up steam for another leg upwards.
Another positive, the 50-day moving average has turned upwards and has once again been breached on the upside by the dailies and could be building towards a long-term buy signal as it is narrowing the gap with the 200-day moving average, which could see the pair eventually cross on the upside.
Resistance levels can be seen around 1.0789-99, 1.0980 and 1.1059 with support placed at 1.0577, 1.0507 and 1.0495.
By Justin Pugsley, Markets Analyst, MahiFX