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Fundamental Forecast for EUR/USD: Neutral

- Twenty year seasonality trends suggest EUR/USD could slip in May.

- The retail crowd remains net-short EUR/USD – see live SSI updates.

- Read the EUR/USD quarterly forecast, “EUR/USD Stuck in No Man’s Land’s Headed into Q2’16 – Don’t Discount ‘Brexit’”

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After another rough week for global equities, higher yielding currencies, and risk-correlated assets, it’s a good time to step back and reassess how we’ve arrived here. One common thread runs through the past few weeks: central banks aren’t looking as supportive as they were at the dawn of Q2’16. Indeed, in the second half of April, the Bank of Japan failed to step into markets to stop a rapidly rising Japanese Yen, while various Federal Reserve officials have started to step up their hawkish tone in preparation for a possible June rate hike. The liquidity spigot appears to be shuddered.

For the Euro, these developments – that central banks aren’t as quick to act during years past – started to materialize back in March. At the March ECB meeting, President Mario Draghi made clear that the ECB would no longer be targeting the FX channel via its unconventional easing policies. As we wrote at the time, this should have (and has in actuality) given the Euro room to breathe. This was an important psychological shift: if the ECB felt that it could no longer effectively keep the Euro down, why would the market have faith that it would itself?

Alas, the ECB may be vindicated thus far. The Citi Economic Surprise Index for the Euro-Zone, a gauge of economic data momentum (actuals versus expectations) closed last week at -11.0, up from -22.0 on April 1. Similarly, the 5-year, 5-year inflation swap rate has increased from 1.411% to 1.464% over this same timeframe. As a result, overnight index swaps and EONIA forward rates have pushed back the implied timeframe for more easing from the ECB from October to December. Implicitly, expectations for future rates have become less dovish, which may be supporting the Euro.

As long as economic data continues to improve and inflation expectations steadily point higher – evidence that the ECB’s current set of policies are having their intended impact – then traders shouldn’t be counting on the ECB to step back into the market any time soon. The forthcoming calendar is loaded with important data from Germany and the Euro-Zone, but market participants will be eying Friday’s dual Q1’16 GDP releases as the capstone to a busy week. As always, no one individual set of data is too important: it’s important to view the updates in aggregate.