DailyFX
Forex: Euro Will Respond to ECB Whether They Hold or Increase Stimulus
John Kicklighter

Talking Points:

  • Dollar: Is the Bullish Taper Drive Running on Fumes?

  • Euro Will Respond to ECB Whether They Hold or Increase Stimulus

  • British Pound Strength Eroding as Hike Optimism Fades

Dollar: Is the Bullish Taper Drive Running on Fumes?

A quick look at the Dow Jones FXCM Dollar (ticker = USDollar) reveals the bulls are struggling to keep the control over the market. The index shows the greenback probing the floor of a three-month rising trend channel – a threat of correction reflected equally across EURUSD, AUDUSD and USDJPY. The lack of progress is a fundamental concern. Between the two dominant market themes for the greenback and broader FX market, both risk trends and relative monetary policy should be theoretically offering support to the greenback. And yet, the currency is threatening to suffer a move lower. This difficulty may turn the tide for the currency’s persistent upside drift in otherwise steadfast markets. In other words, the dollar may be prone to a short-term tumble unless something more ‘dramatic’ happens.

The safe haven’s best chance to forge a meaningful rally from its recent lull would be the realization of another wave of ‘risk aversion’. The S&P 500 as a benchmark for global equities and general investor sentiment has stalled just above a trendline that has maintained the current bull phase since the beginning of 2013. However, depending on such an extraordinary volatility event is synonymous with positioning for a low probability outcome. Furthermore, we have seen the currency’s sensitivity to risk moves dampen such that its correlation to the FX Volatility Index is essentially at zero. That means a sentiment-based move would need to be strong to reengage the dollar.

Outside of the ‘risk-on / risk-off’ theme, the dollar’s steadfast driver (relative monetary policy) is losing its inherent bias. Since the FOMC’s first Taper on December 18 – which was followed by another tightening move on January 29 – the USDollar is virtually unchanged. And this is certainly not a function of dovish sentiment bleeding in. Philadelphia Fed President Plosser remarked this past session that the pace of cuts may need to be accelerated, while Atlanta Fed President Lockhart said the $10 billion trimming was now ‘default’. Tangibledata like Friday’s NFPs may amplify speculation, but the more effective means may be relative dovish shifts by counterparts like the ECB, BOJ and BoE.

Euro Will Respond to ECB Whether They Hold or Increase Stimulus

The European Central Bank’s balance sheet (a measure of its stimulus contribution) is at a more-than-two-year low having dropped nearly 30 percent from its June 2012 peak. In stable financial markets, that is a considerable source of strength for the Euro. Against a backdrop of steady or expanding stimulus programs from major counterparts, this relatively ‘austere’ bearing boosts market rates and supports speculation of more timely rate hikes – a fundamental element for pricing currency. Yet, neither global nor local conditions in the Eurozone are particularly robust. And, the tepid growth outlook, dubious banking system’s health and sovereign exits from rescue programs are generating concern.

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