ECB can’t keep a lid on EURUSD

Since the start of ECB President Mario Draghi’s commentary EURUSD has rallied more than 100 pips even though its 2-year inflation forecasts were well below the ECB’s preferred rate of annual headline CPI of 2% or just below.

So what drove the EUR higher? A lot of the talk out there is of a less dovish Draghi. The ECB did not discuss a potential rate cut at this meeting and even with the fall in inflation in recent months the Bank still believes that long term inflation expectations are firmly anchored. There had been some (unjustified in my view) expectations that Draghi and co could dangle the prospect of QE or other radical action in front of the markets to show off their deflation fighting credentials. However, he was hardly hawkish, and instead stuck to his most recent dovish tone and reinforced the ECB’s forward guidance to keep policy loose for a prolonged period.

This leaves us with the dollar as an explanation for EUR strength this afternoon. The second reading of US GDP was revised up to 3.6% from 2.8% initially, which sent the dollar sharply higher and markets into a tail spin as it boosted expectations of Fed tapering in January. However, on closer inspection the US data was not as good as the headline number suggested. A lot of the increase was down to inventory re-building, which is all well and good if you have consumers ready to go shopping; however the consumption index in this GDP report fell to its lowest level since 2009. So US companies are busily producing stock piles of goods, yet the US consumer is holding back.

The light bulb moment in the markets that the US growth surge could be a blip and potentially may be reversed in the coming quarters coincided with the dollar index hitting a major resistance level at 80.85. This is the top of the daily Ichimoku cloud and may have been used as a good selling opportunity, especially as the fundamentals weren’t that supportive of the buck after all.

This leaves us relying on tomorrow’s NFP data to give the FX market the direction that it needs. Interestingly enough, Treasury yields have fallen by less than the dollar, and a 10-year Treasury yield of 2.85% still makes it seem like the dollar is lagging behind fixed income and could be due a correction.

In EURUSD we are currently above the key 1.3630 resistance level, which is the 61.8% Fib retracement of the late Oct to early Nov sell-off. A daily close above this level is a bullish development that may require a very impressive NFP number to break the recent EUR dominance.