FX Update: ECB offers nothing new for EUR. Biden Tax Revolution?
Head of FX Strategy
Summary: The ECB meeting yesterday failed to provide new developments for EUR bulls, although the euro has bounced back again today. In the US, a Biden proposal to nearly double the capital gains tax would represent the most significant shift in US tax policy in forty years if it sees the light of day. And after the consolidation in US treasury yields, USDJPY is at a crossroads.
FX Trading focus: EUR tries to rally again despite ECB non-event, Biden tax revolution
The ECB meeting yesterday was a no-holds barred attempt to admit as little new guidance change through the cracks as possible, as Lagarde insists the ECB wants a look at June forecasts before altering guidance. The market was trying to sell EU sovereign bonds and buy EURUSD anyway, but the dovish insistence that it is premature to discuss any change in PEPP purchases and that inflation expectations are a very different place than in the US, etc. won out yesterday, and the EUR unwound its modest rally attempt by later in the day. This morning, however, the EURUSD pulled back higher, a strong performance that could point us back toward the cycle highs if the 1.2103 level is taken out, as discussed in the chart analysis below. Lagarde said that she won’t present the ECB strategy review until “the fall” time frame and we have to keep in mind for the longer term that the truly important policy push from here is fiscal, and that means the focus has to be political – and this fall, the most important political decision will be made in the German election, as highlighted and discussed in Steen’s Macro Digest yesterday.
The EURUSD rally is approaching the last big retracement level ahead of the 1.2349 top, the 61.8% Fibo retracement of the sell-off wave to 1.1704 at just above 1.2100, although on a daily close basis, the 100-day moving average (purple line) has been a solid trend indicator in recent history. GDP data next week will remind us why the USD surged in Q1 relative to the euro as the EU economy stagnated and even contracted in places on the renewed Covid wave and lockdowns, while the USD enjoyed the strong resurgence in yields on a wild burst of stimulus packages. In Q2, the US stimulus effect will fade quickly and dampen the offset of a resurgence from the opening up of the economy, while the EU will open up as it also enjoys the surge in demand for exports on stimulus and opening up abroad. If US real yields stay tamed and we avoid any new major setback in risk sentiment (this is our key worry), the EURUSD may be ready to charge higher now rather than later. In terms of risk-reward, current levels are difficult for bulls to express a view, who have yet to see a pullback of any reasonable magnitude since the 1.1704 lows.
Biden proposed massive US capital gains tax increase
To pay for future social spending initiatives, US President Biden will propose a near doubling of the capital gains tax for those earning more than $1 million, a policy that, if it succeeds, would represent the largest shift in the US tax code since the Reagan Revolution in trying to reverse the widening inequality gap of the intervening forty years. This will be a part of his American Families Plan to be announced before a joint session of Congress next Wednesday. It will be critical to track this story for whether the votes in Congress are there before the 2022 Mid-term election for this and his other tax code proposals. It is generally USD and US-asset negative, although in trying to pay for future spending, it does allay the worst fears of MMT-style profligate spending that would present the worst outcomes for US real yields. Biden also proposed a staggering goal of reducing US CO2 emissions by 50% by 2030 at a climate summit yesterday and a Politico article outlines how he will pursue climate goals even if Congress won’t move on policy.
Russian ruble losing some of its geopolitical discount
The ruble rallied sharply yesterday on the news that Russia will pull its troops back from the Ukrainian border to end its “military exercise” there. This allowed a dramatic reduction in the “geopolitical discount” the currency has suffered in recent months. Today, the Russian Central Bank is expected to announce a 0.25% rate hike that would take the policy rate to 4.75%. USDRUB trades near the 200-day moving average just above 75.00 and could be set for a bout of further strength if oil prices stay stable to higher here and the Russian central bank hikes as expected today and continues to signal further hikes to come. (Just before screen-time update: the central bank hiked 50 bps, a solid support for the RUB, though guidance is for a rate hike at "one of next two meetings" and 2021 average anticipated rate 4.8%-5.4%, suggests they see a pause in hike trajectory soon.)
USDJPY at a technical crossroads
The USDJPY pair has reached a technical crossroads as it traded down to a nearly exact touch of the 38.2% retracement of the huge rally wave off the January lows at 107.79. In this morning’s Saxo Market Call, I also noted that the lows also coincide with the current top of the Ichimoku cloud on daily charts. The key coincident indicator remains the long end of the US treasury yield curve, where the recent consolidation of bond yields lower has boosted the yield-sensitive yen (which is set to stay very yield sensitive on the Bank of Japan’s recent capping of 10-year yields at 0.25%). A further drop in US yields would see the focus shift to perhaps the 105.75 area 200-day moving average, where the key 61.8% Fibo retracement also sits, although that would require a considerable further US treasury rally. A fresh sharp rise in yields is likely required to get the bulls back on board, meanwhile.
Busy calendar next week
The macro calendar heats up next week with interesting inflation (Germany Thursday and Euro Zone Friday) and GDP (Germany and France data, while an FOMC meeting is up on Wednesday, the same day as Biden is set to speak for the first time before Congress as noted above. Surely by the end of the week we get a firmer sense of whether the USD is set to tilt lower again (the default position if risk sentiment avoids a train-wreck and US real yields remain sidelined).
Table: FX Board of G-10+CNH trend evolution and strength
Trend signals are still mostly weak on the FX Board, with the USD registering the strongest reading on its recent dip. Sterling is not doing well either as momentum has shifted strongly negative over the last two days, while CAD has shifted positive in the wake of the BoC meeting.
Table: FX Board Trend Scoreboard for individual pairs
We are still in a phase of choppy price action, but the USDJPY sell-off and EURUSD rally are at existential levels that begin to change the picture and it wouldn’t take much of an impulse in either direction in AUDUSD for that pair to show a directional clue.
Upcoming Economic Calendar Highlights (all times GMT)
- 1030 – Russia Central Bank Rate Announcement
- 1345 – US Flash Apr. Markit Manufacturing and Services PMI
- 1400 – US Mar. New Home Sales
- 1435 – Bloomberg Climate Panel featuring ECB’s Lagarde, US Treasury Secretary Yellen