by Cliff Wachtel, FX Empire
How The USD Rises Despite Falling US Rates. An FX Traders' weekly EURUSD fundamental picture
The following is a partial summary of the conclusions from the fxempire.com weekly analysts' meeting in which we cover outlooks for the major pairs for the coming week and beyond.
See here for our technical outlook, and here for a comprehensive EURUSD weekly outlook.
Top EURUSD Drivers: Risk Aversion, Data Advantage Boost USD Despite Falling US Rates
Risk Aversion Trumps Lower USD Yields
The pair's 2 big moves, on Tuesday and Thursday, illustrate how risk aversion has the pair's key fundamental driver.
The big drop for the pair came on Tuesday despite falling US 10 year Treasury note rates, mostly due to rising fear over the impact of additional exchanges of economic sanctions between and the West (though poor Spanish unemployment data EU PPI didn't help the EURUSD's performance either).
The pair's big move up for the week came on Friday, in response to reduced fears of a Russian invasion of Ukraine as Russia ended military exercises on Ukraine's border and began pulling back its forces.
Although USD resilience in the face of falling US yields seems odd, history has shown that when risk aversion is paramount then investors will buy both Treasuries (thus driving rates lower) and the USD, both top safe-haven assets. For example, we saw this behavior during the Great Financial Crisis and 9/11.
US Data Advantage, ECB Comments Fuel Speculation On Coming USD Rate Advantage
The other key fundamental EURUSD drivers last week were the continued better US economic data and dovish ECB comments.
Economic activity in the Eurozone was revised lower for the month July due to slower growth in the service sector. Improvements in Spain were offset by weakness from Germany and Italy. Perhaps this data, and the recent losses in the euro, had investors positioning for more dovish ECB comments at the coming Thursday ECB meeting.
These negatives were somewhat offset by News of Portugal's Banco Espirito Santo rescue (even though hitting bank shareholders and junior bondholders with losses will hurt this and similar banks' chances for future access to capital via share offerings or additional debt sales).
Italy tipped into recession on Wednesday. A surprise second consecutive contraction in Italy's economy, per 2Q GDP figures, pushes the Eurozone's third largest economy back into recession. Bad as this is by itself, it also carries additional, spreading ramifications beyond falling Italian stocks and rising in Italian yields.
As we've noted repeatedly, particularly in our posts about the failed EU banking union, none of the real causes of the EU crisis has been addressed, nor have there been any meaningful reforms to prevent another round of EU contagion risk. The complacency about EU crisis risk, born of ECB president Draghi's great bluff in 2012 that the ECB actually could do all that was needed, rests mostly on sheer confidence that everything will somehow work out, despite the lack of reforms or meaningful growth.
This latest recession risks raising the record low borrowing costs for Italy and the rest of the GIIPS and it could metastasize into a crisis if that a sustained spike in rates comes, and starts a rapid outflow of the capital buildup of the past two years. As Portugal's BES troubles have reminded us, the EU's periphery is on its own if they face a bank failure. There is no Fed-like safety net or anything like it, as the banking union doesn't even exist yet and even when it does, will have too little money and too much bureaucracy to support confidence that the EU can respond quickly to banking crises in member nations, even those that threaten to spread to all of Europe and beyond.
In contrast, US data continues to support the slow but steady recovery theme. The last monthly jobs reports missed forecasts, but not by much and were still over 200k. The 4 week moving average of weekly new jobless claims continued falling after beating the latest forecasts, and services PMIs beat forecasts.
Given the above US growth advantage over Europe, it's no surprise that ECB President Draghi used the ECB's monthly press conference to remind markets of the coming USD interest rate advantage, as the Fed would likely raise rates long before the ECB, perhaps even before the ECB had even finished easing.
Granted, one could dismiss his remarks as another attempt to jawbone the EUR lower, however the reality of the US's better economic performance and lower exposure to Russian economic sanctions compared to Europe, justify the ECB's taking a more dovish position than the Fed.
EURUSD Lessons For The Coming Week
So, what did we learn for the coming week and beyond?
Highlights, Summary Of ECB Policy
Highlights of Draghi's remarks from the ECB's monthly rate statement and press conference include:
- USD Rates Will Be Higher Than The EUR's For A Long Time: The Fed is winding down its own QE and is expected to begin raising rates by no later than late 2015, possibly as early as late 2014. The ECB is still looking to ease further and has no timetable for raising rates.
- More Stimulus Coming: The ECB is intensifying its preparation for some kind of outright purchases of asset-backed backed securities as an additional form of stimulus.
- The ECB Views EU Recovery As Slow, Uneven: It's slow even in the more prosperous countries, and non-existent in many of the weaker ones. As noted above, on Wednesday Italy had officially tipped into recession.
- ECB Is Worried About Economic Effects Of Russia Sanctions: On Thursday Russia banned food imports from the European Union in response to the financial sanctions enacted by the EU last month. Although it's too soon to assess the economic damage, Russia is the world's 5th largest food importer. The prospect of rising energy prices is a longer term concern, although for now crude oil prices are trending lower.
EU's Weaker Economic Performance Vs. US Continues
Peripheral Banks Under Suspicion With BES Bailout: The Portuguese bank woes have shaken confidence and risk renewed scrutiny on peripheral banks and the lack of EU safety net, even after the banking union that was agreed on earlier this year
- Italy Falls Back Into Recession: Last week Italian GDP contracted for a second consecutive quarter for the third time since the start of the GFC.
- EZ Retail Woes: Even German retailing is weakening.
- German Manufacturing Slowing On Reduced Europe Demand: Even without considering the loss of Russian, business, Germany's economic mainstay, manufacturing, is suffering from falling demand from its neighbors.
(via businessinsider.com here)
In contrast, US data continues to show a slow but persistent improvement.
When Risk Aversion Is Strong, USD Can Rise With Falling US Rates
To reiterate what we noted above, although currencies generally rise or fall with their benchmark interest rates, that's not the case with the USD when fear is high, because that risk aversion not only drives up demand for dollars, it also drives up demand for US Treasuries and thus sends treasury yields lower.
Top Calendar Events To Watch
The coming week's calendar is a bit light, with Europe having most of the events likely to move the pair. The most important EUR calendar events are the second quarter GDP reports from Germany, France and the Eurozone along with the German ZEW survey. For the USD, the top event is US retail sales. The Fed is believed to watch the JOLTS report carefully, though we doubt it will influence Fed thinking in the near term.
China: CPI, PPI (y/y)
EU: German, EU, ZEW economic sentiment survey
US: JOLTS job openings
Japan: Preliminary GSP q/q
China: Industrial Production y/y, fixed asset investment ytd/y, retail sales y/y,
EU: Industrial production, German 10 year bond auction
US: Retail sales, business inventories m/m (relevant because the recent bullish GDP figure was questioned due to high inventories), 10 year bond auction, NFIB small business optimism survey
EU: French, German, EU prelim GDP q/q, EU final CPI y/y
US: Weekly new jobless claims (currently trending lower, bullish for the USD and thus bearish for the pair if that continues
US: PPI m/m, Empire state mfg index, TIC net long term purchases of US assets by foreigners, capacity utilization (an indicator about future trends in jobs, capex), industrial production, prelim UoM consumer sentiment
Biggest Questions & What To Watch To Answer Them
- Will treasury yields continue to fall, and if so, will the USD remain resilient? As noted above, if geopolitical events continue scaring investors, then the EURUSD remains under pressure. If markets relax, then the pair likely gets a bounce this week.
- Will the risk aversion sentiment ease? The main thing scaring markets was the risk of a Russian invasion of Ukraine and the economic damage of further sanctions that would follow. Russia appears to be pulling back. If so, then that would support the pair and likely allow it to attempt a bounce off of the strong support levels where it closed last week.
- Is the EURUSD downtrend over? For the coming week, if the Russia-Ukraine situation doesn't escalate, then probably. Longer term, the Eurozone's economic weakness, and the EURUSD's technical weakness on the weekly charts, both point to further moves lower, as noted above.
Sample Retail Traders Positioning
Forex factory's real time sample of retail trader positions shows:
- A modest shift to short positions from the prior week.
- Since July traders shifted strongly to the long side, anticipating a resumption of the uptrend that never happened, and stayed long regardless of the trend's continued moves against them.
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DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.