FX Update: EURUSD trying to reverse higher ahead of ECB

FX Trading focus: Key USD pairs poking near reversal territory. EURUSD up after EU CPI.

I noted yesterday that the AUDUSD was ignoring Tuesday’s dovish RBA meeting and that the Aussie seemed to correlate with risk sentiment rather than the impact of that meeting and last night’s Governor Lowe speech on short AU yields, which have fallen sharply this week. Perhaps some Aussie buyers here are justified in maintaining the view that the RBA will eventually converge with the Fed and others. After all, the RBA lost a considerable deal of credibility by having to fold on its yield-curve-control policy late last year. But the mismatch between the strength in the Aussie relative to the falling AU yields leads me to believe that we have a simple case of inter-market correlation of AUD and risk sentiment and if the latter rolls over, the Aussie might be taken with it. If not, the driver for sustaining current AUDUSD levels and higher would likely have to be a quick fall in US short yields, and we are likely far too early in the cycle for that.

In any case, the technical situation is pivotal in AUDUSD, in equities, and in EURUSD ahead of the rest of the week’s important event risks. The first of these is today’s ADP employment change, which is expected to show the lowest payrolls growth in nearly a year, but this looks rather baked into the cake after both the White House and the Philadelphia Fed’s Harker were out yesterday suggesting that Friday’s official January employment report will be week. Apparently, at least for the official NFP data series, some omicron-covid absences could be registered as negative payrolls, so we may see an outright negative number Friday for the NFP change. That could be offset by surprisingly higher earnings growth, but let’s see how the market treats the data.

The EU January CPI estimate out today surprised strongly to the upside, as the headline was out at +0.3% vs. -0.4% expected month-on-month and +5.1% year-on-year vs. 4.4% expected and 5.0% in December. This inspired EURUSD to have a poke above 1.1300. Can the market treat EURUSD like AUDUSD over the ECB meeting tomorrow, i.e., ignore even the ECB maintaining wait-and-see until at least March economic forecasts, etc. and bidding up EURUSD and engineering a full reversal of the recent sell-off? As with AUDUSD, I would argue this is only likely if risk sentiment continues to smash higher for a fuller reversal of the recent slide. If the ECB does crater on its guidance and opens the window for rate rises, the euro likely wouldn’t need much support from the sentiment angle.

Chart: AUDUSD
The AUDUSD has managed to rally to the approximate half-way point from the highs late last year to the lows below the critical 0.7000 area. In the short term, given the dovish RBA’s negative impact on AU rates eroding the attractiveness of the currency on the yield spread front, that the short-term Aussie outlook will correlate closely with the direction of risk sentiment, which has likely provided the chief inspiration for the move off the lows. The ECB meeting tomorrow could also change the narrative for the US dollar if ECB-Fed policy convergence is seen in the cards. Technically, the pair still needs to rise up into the 0.7200-50 zone to suggest a more decisive reversal here – very pivotal zone here and we should have a better read on the lay of the land on the Friday close.