Is the EUR/USD Confused?

By FX Empire Analyst - Barry Norman
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Today, the US market is closed in observance of Labor Day. So trading will be thinner.

There isn't much in the way of economic data. The final PMI report shouldn’t give much direction. Various EU officials speak, which might move the markets, but most likely not decisively. 

Last week, the marquee event was Mr. Bernanke's Jackhole speech. Come Friday markets anticipated  investors being sidelined ahead of the keynote speech of Mr. Bernanke, but that was absolutely not the case.

The EUR/USD changed hands in the 1.25 area at the start of trading in Europe, but European markets were fast captured by a remarkable risk-on move. The exact reason for this move wasn’t that clear. A lot of various messages reached markets. The eco data (poor Japanese data, European labor and inflation data) could hardly be considered as risk supportive. The news flow on the EMU crisis management was also mixed, but as yield spreads to Germany narrowed (except for Spain) at that time, investors leaned towards a favorable reading of the EMU news.

Some press reports stated that the ECB would get swiping powers to monitor the EMU banking sector. French ECB member Coeure said that the ECB was preparing the possibility of intervening in the bond market, but it should be subject to ‘strict conditionality’. However, this ‘strict conditionality’ for Coeure apparently is limited to a country request for EFSF/ESM support.

Just hours before, there were rumors about Weidmann resignation, while ECB’s Asmussen pleaded for IMF involvement. However, markets took it as an indication that the ECB is finally preparing something ‘big’. Equities found a better bid and EUR/USD started an impressive short squeeze, clearing all the intra-week resistance levels.

The pair even regained the recent correction top of 1.2590 at the onset of US trading. The pair reached an intraday top at 1.2628 early in the US. Bernanke didn’t announce the imminent start of another bond purchasing program, but he did defend past non-conventional measures, saying they were effective and helped the economy in the face of strong headwinds. He discussed costs and benefits of non-conventional policies to conclude that risks attached to these tools have not materialized and the Fed has the power to minimize these negative effects should they appear. As furthermore Bernanke stressed that the economic situation, in particular the unemployment is unsatisfactory, it logically follows that the FOMC will decide to ease policy, if things doesn’t improve rapidly and sustainably. As it was only the timing of such a move that was missed, the initial disappointment disappeared rapidly.

In terms of EUR/USD, it spiked lower (risk aversion), but rebounded fast, safe-guarding a large part of the intra-day gains. Despite the gains, the move wasn’t technical very relevant (see lower). EUR/USD eventually closed at 1.2579, versus 1.2506 on Thursday eve.

Over the weekend, the official Chinese PMI report confirmed the weakening seen earlier in the HSBC measure. However as it raises hope on more stimulus, Chinese (and Asian) equities are doing well. The flow of rumors on the euro debt crisis and the imminent response to it by the ECB continued unabatedly. It seems now that national central banks will receive on Tuesday, a preparatory document from the ECB with three options for the new bond buying program (various assets, yield cap or spread targeting). This will be discussed at the ECB meeting that unusually starts on Wednesday. However, neither factors had much impact on EUR/USD that still trades around 1.2575. Optimism on decisive ECB action would be euro positive, but markets have already discounted a lot of optimism. 

The EUR/USD touched a new 2012 low at 1.2043 on July 24. At the end of July and in August, EUR/USD rebounded after ECB’s Draghi said that the ECB would do whatever is needed to preserve the single currency. The pair reached a corrective top at 1.2444 and settled in a tight sideways range between 1.2242 and 1.2444. From a euro point of view, markets were waiting for the details/conditions of the ECB bond buying plan. From a dollar point of view, markets were pondering the chances for further Fed easing. Until last week, both factors were in balance, keeping EUR/USD in a sideways trajectory.

The dovish tone of the August FOMC minutes provided a good reason for EUR/USD to break above the 1.2444 range top, improving the short-term picture in this cross rate. In a longer term perspective, we are not convinced that the rise of EUR/USD should continue.

Now markets are focused on Mr.Draghi and the ECB statement on September 6th.

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