Global Daily – More than meets the eye

door: Georgette Boele

Global-Daily-Insight-26-June-2014.pdf (78 KB)
  • More to EUR/USD than meets the eye
  • Peripheral bond demand and EONIA curve movement have supported the euro
  • …but unlikely to do so going forward…and US dynamics to add pressure on EUR/USD as well

More to EUR/USD than meets the eye

EUR/USD is the most widely traded and most liquid currency pair. Therefore, it is highly analysed by researchers. With all the focus and attention on it, it often defies expectations as is the case with the great football stars during World Cup in Brazil. In the case of EUR/USD it is often underestimated that high tradability and liquidity generally reduces the likelihood of substantial directional movements. Why is this? Higher tradability and liquidity implies that it is used for more diverse purposes. Therefore, there are more factors that can influence the price action in EUR/USD. For example, demand for eurozone government and peripheral bonds result in inflows into the eurozone, supporting the euro. Another example is that negative deposit rates and an ECB’s forward guidance signalling that official rates will remain on hold for long, make the euro unattractive to invest in. As a result of these different forces, there will only be a large directional move if all these forces align and point into the same direction. We would like to give you an update of the recent drivers and our view going forward.

Peripheral bond demand has supported the euro again

Contrary to our expectations, demand for peripheral bonds has provided support to the euro again recently. This relationship broke down in May, when Draghi signalled at the ECB press conference that in June, more monetary stimulus would be coming. This signals that non-eurozone investors are again attracted by the relatively high yields on peripheral bonds. Demand for peripheral bonds may continue, but its relationship with the euro will likely be more volatile going forward.

EONIA curve behaviour has also supported the euro…

There have been some interesting developments on the EONIA curve recently. Since the ECB meeting in May, rates on the different EONIA futures have moved down on expectations of more monetary stimulus to be announced in June. Since the ECB has announced a broader than expected package of monetary stimulus in June, EONIA rates reflected by the futures have behaved erratically. After the announcement 1-month EONIA rates for January moved to negative territory. But soon thereafter they moved back into positive territory again. Then, the 1-month EONIA rates for March moved into the red, but also this was temporary. Finally, the 1-month EONIA rates for February repeated this behaviour. At the time of writing EONIA rates for the different months have moved back to positive territory. This is somewhat surprising, taking into account the upcoming TLTRO’s (September and December) and the possibility of more TLTRO funds every quarter next year. It appears that eurozone banks are currently adjusting their liquidity management to profit the most from the announced ECB measures. This behaviour of the EONIA curve has supported the euro despite the divergence in 3M and 2Y rates across the Atlantic. Going forward, we expect that the dovish forward guidance by the ECB and the TLTROs will result in a downward adjustment of the market’s view about the EONIA curve. In turn this should hurt the euro.


…but better US data in coming months to hurt EUR/USD

Despite weaker than expected first quarter GDP print overnight, incoming US data suggest a rebound in the second quarter. However, the impact so far has been limited, because these better data have not resulted in an adjustment in the market’s view about interest rates in the US. Market expectations about 3M US interest rates for the end of 2015 remain anchored around 1%. Our view is for 3M interest rates to be around 1.7% at the end of 2015, because we anticipate more Fed rate hikes in 2015. It is likely that higher inflationary pressures, a lower unemployment rate and stronger US growth data will change the communication of the Fed, resulting in an adjustment of the market view about the Fed’s tightening path. This will result in further downward pressure on EUR/USD.