3 Factors to Determine EUR/USD’s Next Move

DailyFX

Following the recent breakout, the EURUSD will now look to the Fed’s Beige Book, US corporate earnings, and equities in search of a catalyst to sustain the rally.

After consolidating below 1.3150 for the past week, the EURUSD finally broke out to upside on Tuesday, rising to its highest level in 7 weeks. What was interesting about the move, however, was the lack of a specific catalyst.

The EURUSD took its cue from US equities, which recovered strongly. The sudden improvement in risk appetite even helped the euro shrug off the news that German investor confidence deteriorated significantly. It should be no surprise that 1.3150 is a key level in the EURUSD, and when it was finally broken, the currency pair jumped above 1.3180 in a matter of minutes. Afterwards, EURUSD slowly ticked higher, with the move extending all the way to 1.32.

Although a number of policymakers took to the podium, including European Central Bank (ECB) President Mario Draghi, the comments had very little impact on the EUR. Draghi spoke about 90 minutes before the breakout and reiterated the potential for downside risks. The breakout actually occurred right as the European markets closed and around lunchtime in the US, which suggests that end-of-day position adjustments may have been responsible for the move.

The question now is whether the rally can be sustained, and with no major Eurozone data on the economic calendar for the rest of the week, its sustainability will hinge upon Wednesday’s Federal Reserve Beige Book report, U.S. corporate earnings, and any price movement in US equities.

If US stocks climb to new highs, the EURUSD could find its way to 1.33. From there, the next area of resistance is at 1.3220, which is the 50% Fibonacci retracement of the selloff that occurred between February and April.

Still, the outlook for the Eurozone itself leaves a lot to be desired. Aside from Draghi's cautionary comments, investor confidence also plunged. The German ZEW survey dropped to 36.3 from 48.5, while the Eurozone ZEW survey dropped to 24.9 from 33.4.

Investor confidence clearly took a big hit in the month of April, as concerns about Cyprus, German data, and possibly even US data overshadowed the rise in equities. Investor sentiment can be fickle, however, so the real question lies in business confidence, although the IFO report is not scheduled for release for another week.

In contrast to the ZEW survey, Eurozone CPI soared in the month of March. Consumer price pressures jumped 1.2%, up from 0.4%, as energy costs rise. For the ECB, price pressures are not a major concern at this time, and from a fundamental perspective, Eurozone fundamentals do not support the rally. Therefore, its sustainability hinges on the US dollar component of the pair.

US Data Shows “Uneven” Recovery

The US dollar ended Tuesday lower against all major currencies except for the Japanese yen (JPY). The latest economic data provided the Federal Reserve with little reason to taper asset purchases in the near future (see “New US Data Has Fed’s Hands Tied”).

We are beginning to see unevenness in the US economic recovery, and given recent disappointments, the Fed needs to be careful about prematurely reducing stimulus. While one month worth of weaker data doesn't make a trend, if these signs of slower growth persist, the central bank won't be able to make any changes in monetary policy until the fourth quarter.

New York Fed President and Federal Open Market Committee (FOMC) voter William Dudley, who spoke Tuesday morning, agreed, saying that he "favors continuing QE after the March job market slowdown" and cautioned against declaring victory "prematurely." Chicago Fed President Charles Evans, who is also an FOMC voter, said the US can't be complacent about the economic outlook. He expects the fiscal drag to wipe out between 1% and 1.25% from GDP. Fed Governor Elizabeth Duke, on the other hand, is more optimistic and said she would like to see rates higher since the economy is stronger.

Aside from consumer prices, housing starts and building permits were also released Tuesday morning. Starts were strong, rising 7% in the month of March after a significant upward revision the previous month. February starts were revised from 0.8% to 7.3%. Unfortunately, building permits dropped 3.9% that same month, with the past month's report revised down to 3.9% from 4.6%.

While the large increase in starts in February and March overshadow the drop in permits, it won't be enough to ease the Fed's concerns about the pace of the recovery. Industrial production increased 0.4% last month, but manufacturing production dropped 0.1%. The Fed’s Beige Book is scheduled for release on Wednesday, and we will be watching closely to see if the recent deterioration in data persisted into April.

2 Primary Catalysts for the British Pound (GBP)

The UK's consumer price report did not have a significant impact on sterling, as the data came out right in line with expectations. Consumer prices grew 0.3% in the month of March, leaving the annualized pace of growth unchanged at 2.8%. Core prices increased slightly more than expected, but this was offset by weaker-than-expected import price growth.

Based on these numbers alone, inflationary pressures have not changed significantly over the past month. This leaves Wednesday's UK employment numbers and Bank of England (BoE) minutes as the main drivers of volatility in the British pound (GBP).

Based on the PMI reports, job losses could accelerate as the manufacturing and service sectors saw weaker labor market conditions. However, the key lies in the BoE minutes and whether they reveal a central bank that has moved closer to restarting quantitative easing (QE).

Back in March, the central bank's worries about inflation overshadowed their concerns about growth. At the time, the GBPUSD was trading below 1.50, and before the April 4 meeting, the pair was trading around 1.51. As a result, we don't think that their currency-driven concerns about inflation have changed much, especially since manufacturing, service, and construction sector activity improved in March.

Bank of Canada (B0C) Policy Decision on Tap

All three commodity currencies rebounded against the US dollar on Tuesday, but the gains in the Canadian dollar (CAD) were far more limited than those seen in the Australian (AUD) and New Zealand dollar (NZD).

The CAD is treading water ahead of Wednesday’s Bank of Canada (BoC) monetary policy announcement. While interest rates are expected to remain unchanged from the current level of 1%, there is a reasonable chance that the BoC will drop its call to raise interest rates.

Since the last monetary policy meeting in March, Canada reported its largest one-month job loss since the recession four years ago, as well as an unexpected trade deficit. There has been good news, however, which included stronger retail sales, higher consumer prices, and stronger manufacturing activity, but that may not be enough to ease the concerns caused by the job losses and the slowdown in the US recovery.

If the Bank of Canada drops its bias to raise rates, we can expect USDCAD to hit 1.03. However, if the Bank remains cautious but continues to say that, "some modest withdrawal will likely be required," losses in the CAD will be limited.

Meanwhile, the moves in the AUD and NZD were driven entirely by the recovery in risk appetite as investors ignored cautionary comments from the Reserve Bank of Australia (RBA).

The level of the Australian dollar is clearly a big driver of monetary policy. In April, the AUDUSD was trading just shy of 1.05, and this led the central bank to say that "the factors weighing on the economy—including the high exchange rate, the waning growth of mining investment, and fiscal consolidation—were likely to persist."

The RBA stressed that while the economy is reacting to rate cuts, the inflation outlook gives scope to ease. Back in March, when the AUDUSD was trading closer to 1.02, the central bank sounded far more optimistic, which goes to show how large a role the currency's value plays on monetary policy.

New Zealand consumer prices were scheduled for release Tuesday evening, and an increase in food and commodity prices in the first quarter point to hotter inflationary pressures.

A USD/JPY Trade for Bargain Hunters

With US stocks rising more than 1%, all of the Japanese yen crosses recovered smartly on Tuesday. The best performer was EURJPY, which rose more than 2%, followed closely by CHFJPY and NZDJPY.

Having traded below 96 on Monday, USDJPY rose above 98 but ultimately settled around 97.50.There were no major Japanese economic reports on the calendar, though consumer confidence was due out Tuesday evening.

We continue to believe that Japanese data will reflect the benefits of a weak currency and easy monetary policy. Bank of Japan (BoJ) Governor Haruhiko Kuroda spoke again, but his comments weren't particularly market-moving considering that he was primarily asked about the central bank's exit strategies.

Having just initiated the new phase of quantitative easing, exit strategies are far from their mind, but of course, as an astute politician, Kuroda was quick to say that the Bank is always keeping the exit strategy in mind, with one possibility being higher rates on excess reserves.

In our opinion, the Japanese yen is in a long-term downtrend, and the recent selloff in USDJPY could be an opportunity for bargain hunters to come in at lower levels.

By Kathy Lien of BK Asset Management

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