http://www.dailyfx.com/forex/fundamental/article/drivers_of_price_action/2011/01/06/EURUSD_Decouples_Further_From_Risk_Trends_Will_a_Strong_US_Labor_Report_Increase_Divergence.html
EUR/USD
Euro bears have returned as a dimming growth picture has cast doubt on the ability of struggling Euro-zone members to pay their debt. Countries and institutions have started to shun the offerings from the PIIGS which is weighing on the single currency. Additionally, a brighter outlook for the U.S. has the greenback gaining favor and becoming more sensitive to risk appetite, leading the pair to further de-couple from equity markets. Indeed, the correlation between the pair and the Dow has weakened to 52% from 64% a month ago. That said we are seeing the two move in tandem today as risk appetite still has a place in determining direction. Meanwhile, we are surprisingly seeing a rise in yield expectations, as inflation pushing above the ECB’s 2.0% target level has raised the scope for a rate hike. The increased potential for tightening has failed to end the Euro’s slide, but could become a supporting factor if dollar strength wanes.
| Driver of Price Action | Current Influence | Correlation | Week Ago | Month Ago |
| EUR Interest Rate Expectations | Low | 0.18 | 0.25 | 0.20 |
| USD Interest Rate Expectations | Low | -0.11 | -0.12 | -0.20 |
| Risk (Dow) | High | 0.52 | 0.59 | 0.64 |
ECB Interest Rate Expectations
ECB interest rate expectations are back at their December highs based on Overnight index swaps, which are pricing in 54.4 bps in tightening over the next year. The outlook for yields hasn’t been this bright since April before the sovereign debt crisis took hold. However, it remains very unlikely that the central bank will raise rates before confidence is restored in the government bond market. Continued price growth could force policy maker’s hands in the second half of the year, but strong odds remain that they will be on hold for the entire year. The course of monetary policy could become clearer following next week’s rate decision and CPI report. Early forecasts are for headline inflation to rise to 2.2% but the core rate to hold at 1.1% as rising energy costs are the biggest culprit. The lack of broader price growth could see the monetary authority continue to see risks balanced, paving the way for more Euro weakness. Discuss this and trading ideas join the EUR/USD forum.
Credit Suisse (OIS) ECB
Source Bloomberg – Prepared by John Rivera
FOMC Interest Rate Expectations
U.S. interest rate expectations have been tracking higher following the strong ADP employment report which raised the outlook for Friday’s Non-Farm payroll report. Markets are now pricing in a 12.3% chance of a 25bps rate hike in June up from 7.2% a week ago. The FOMC is expected to remain on hold though the first half of 2011, but strong job growth could lead to aggressive tightening in the second half of the year. Therefore, confirmation of labor market strength by the Non-farm payroll report may significantly brighten the outlook for yields and provide greenback support. However, weakness in the ISM on-manufacturing employment component and initial jobless claims climbing back above 400,000 has dampened expectations a bit and a disappointing print could sink the dollar.
Source Bloomberg – Prepared by John Rivera
Risk
Equity markets dipped lower on the day but bearish conviction has been limited ahead of the labor report. We are seeing a bit of a pull back after stocks reached their highest valuations since 2008. December department store sales missed expectations casting a shadow over what was deemed to be a string holiday shopping season. A rising trend line puts support at 11,600 for the blue chip index which could be tested if Non-farm payrolls disappoints. Discuss this and other fundamental data in the Economics Forum.
Dow (10 Min)
To discuss this report or be added to the email list contact John Rivera, Currency Analyst: jrivera@fxcm.com
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