The Euro Slides on Draghi Rhetoric

May 7th, 2013
in contributors, syndication, forex

by Marcus Holland,

The Euro has consolidated in a tight 2 big figure range over the past few trading sessions, absorbing the information investors received last week when the ECB cut interest rates by 25 basis points. The move was expected, but comments from Draghi reveal a central bank that was focusing on rhetoric as opposed to action.

The ECB cut interest rates last week on their benchmark refinance rate and discussed the chance that the committee would consider additional measures and a negative deposit rate. Theoretically a negative deposit rate would further discourage placing capital in secured deposits and incent investors to move out the risk curve into assets such as stocks. The technical difficulty of a negative deposit rate makes the likelihood of this process occurring being relatively low, but the ECB want investors to think they are ready to pull the trigger, as an additional tool to appear to be accommodative.

The goal of the central bank is to generate a wealth effect by increasing the values of riskier assets and encourage lending to small business which is currently face difficult lending conditions. The ECB stated that they were committed to refinance operations through mid-2014.

Follow up:

The fiscal course seems to be fading from a path of austerity which helped craft the direction post the European debt crisis. It is very difficult to grow and rain in expenses on the heels of a recession or what was close to a depression. It also appears that France, Spain and Italy would need significant time to reach their deficit targets. German seems on board with allowing the process to be delayed, but its relationship with some of the economic lagers is losing traction.

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The 2-year yield differential between European rates and US rates continues to be highly correlated to the EUR/USD currency pair. Rates in the US are likely to climb prior to European rates, but neither is likely to see any change higher for a significant amount of time. With this in mind, it is likely that the currency pair will remain in a range, similar to the range created by the 2-year yield differential.

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The Bollinger bands (2-standard deviations from the 20-day moving average) are likely to be a good guide of range bound price action. Resistance is seen near the Bollinger band high near 1.32, while support is seen near the Bollinger band low which is slightly below 1.30. With the Bollinger band width (the Bollinger band high minus the Bollinger band low) contracting, historical volatility should continue to move lower. A close above the Bollinger band high or Bollinger band low would likely see continued movement and higher volatility.

Momentum has stagnated with the MACD spread and the 9-day moving average of the spread printing on top of each other. The RSI (relative strength index) is printing near 51, which is right in the middle of the neutral range reflecting a consolidative tone.

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