Market Analysis

Just A Minute

Euro bulls won’t have enjoyed the sight of the euro hitting 3-week lows versus the US dollar [EURUSD] on Thursday ‘s dip and the move below $1.1700 will have led to some long euro positions being liquidated. While that might have cleared away some stale positioning, the question for traders is whether the euro is going to base out or fall further. Each trader will have their own opinion, and each opinion will be based both on a view on the euro and a view on the US dollar. So what might the currency market’s consider is important. On the US dollar side of the equation, one point that traders might focus on is that, as Canada’s TD Securities wrote on Wednesday, the Federal Reserve’s latest minutes reveal “that “many” participants believe the [Fed’s] balance sheet run-off would “contribute only modestly to the reduction in policy accommodation.” In contrast with the market, which has increasingly priced out subsequent rate hikes as the Fed has discussed the balance sheet, much of the FOMC does not view them as substitutes.

This is a marginally more hawkish signal, as it explicitly is not a potential reason to slow down rate hikes in the mind of the Committee.” In the opinion of France’s BNP Paribas, “the bottom line from the Fed now is that, while balance sheet reduction is likely to begin very soon, further hikes in the Fed funds target will be contingent on the recovery in price data that the Fed has long been anticipating actually beginning to materialize.” In a nutshell, if US data is robust then the Fed could continue to tighten even at the same time as embarking on balance sheet reduction. And of course the Fed can do against the backdrop of a greenback that’s weaker now than when 2017 began. Contrast that with Thursday’s European Central Bank minutes for the July 19-20 meeting (when euro/dollar was still around $1.1500) which revealed that even then “concerns were expressed about a possible overshooting in the repricing by… markets, notably the foreign exchange markets, in the future.” The comparison is telling. One central bank has concerns about a possible further rise in its currency, the other seems set out on tighter monetary policy one way or another if the data is robust. Purely from a monetary stance comparison, and while there are multiple drivers of the exchange rate which might change the calculation, it could be argued that the hurdle for renewed euro strength versus the US dollar just got raised.

Written by Neal Kimberley, External Currency Analyst.