Is the euro ready for a deeper correction?

John Hardy

Head of FX Strategy
John Hardy joined Saxo Bank in 2002 and has been Head of FX Strategy since October 2007. He focuses on delivering strategies and analyses in the currency market as defined by fundamentals, changes in macroeconomic themes, and technical developments.

The latest European Central Bank minutes showed a debate on leaving the door open to QE resumption if conditions warranted, ultimately leading to the dropping of this language in the forward guidance. The headlines have seized on the discussion of the volatility of the euro in the minutes and the phrase that this provided: “a source of uncertainty that required monitoring". 

ECB president Draghi offered a stern rebuttal at the most recent ECB meeting to a (likely offhand) statement by US Treasury Secretary Steven Mnuchin that a weak dollar is a benefit to the US economy. The expectations for ECB policy unwinding have gone into neutral over the last couple of weeks, even with the recent recovery in risk appetite, and this kind of language from the ECB, as well as heavy EUR long speculative positioning and a rather sharp deceleration in the most recent PMIs, are making it tough sailing for EUR bulls. 

Speaking of positioning, the JPY short is shrinking but still very large. Often, when the JPY is on the move, it is directly traceable to something else afloat in the markets, whether from direct signals from the central bank, or large swings in risk appetite or bond yields. But this recent move feels qualitatively different and rather significant, as if the market is changing its mind about its underlying assumptions (that the Bank of Japan will forever be the policy laggard and as long as we aren’t seeing a market meltdown, carry trades versus the JPY are a no-brainer) and this could lead to a broad-based repricing of the G10’s cheapest currency.

Chart: EURJPY

From a positioning perspective, and increasingly from a technical one (and a momentum one on the Eurozone fundamental news front), EURJPY is a pair that potentially looks primed for a large move lower on a break in the price action.

The 131.00-50 area is one we have often discussed. The last major attack on this area saw the Ichimoku daily cloud offering support, and now we have the 200-day moving average to contend with, but an ongoing reassessment of the JPY here from the market and a bit of deleveraging as the fundamental support for the strong euro has lost considerable momentum over the last couple of weeks, and a break lower could prompt several figures of potential downside.

Looking ahead

The week ahead looks sure to keep volatility from settling much lower. We have a mid-week testimony from newly minted Fed chair Powell as the main event, with a long question-and-answer session before Congress sure to provide the market with something to chew on. 

Note: the report is supposedly to be delivered today at 16:00 GMT to Congress but I do not recall this report ever being released to the public so long before the Fed chair's actual appearance before Congress; normally it is released in full just before the Fed chair delivers it. 

We also have a look at the Eurozone’s flash February CPI data on Wednesday and then the US January PCE inflation data on Thursday.

The G-10 rundown

USD – the dollar looks firm here, especially versus the euro and the struggling commodity dollars, though it has not yet administered any knockout blows. USDCAD, however, is over the top of key local resistance as the first pair to fully neutralise USD weakness. Fed-linked event risks and any new surge in risk aversion are likely to provide the impetus for fresh volatility.

EUR – as we discuss above, a combination of declining fundamental momentum factors point to the risk of near-term downside until proven otherwise.

JPY – recent strength not easy to connect with a narrative, feels like the market is reassessing the JPY assumptions and the currency could get a boost on any low inflation reports over the next week. Didn’t hurt the JPY to see a modest beat of CPI expectations overnight (January core inflation ex-food and energy were a stout 0.4% and thus a 17-month high).

GBP – sterling maintaining the recent rally versus a struggling euro and could be ready for more if the fortunes of the latter continue to decline. The UK GDP report Thursday was nothing to celebrate, however, with a small miss and UK economy growing at about half of the rate of Germany at the moment.

CHF – locally weak euro seeing EURCHF pushing back lower – 200-day moving average and March 4 Italian election/German SPD vote are perhaps the keys here for whether CHF is set for a larger consolidation higher versus the euro.

AUD – the AUDUSD bounce yesterday was a modest affair and we continue to eye the 0.7750 area (the 200-day moving average, with the 100-day moving average coming in slightly above near 0.7775-80) for the risk of a bigger breakdown. It feels like AUD would be particularly vulnerable to any new risk aversion wave.

CAD – USDCAD has been the first USD pairs to more or less fully neutralise the USD weakness after yesterday’s ugly Canadian retail sales report, but the pesky 200-day moving average hasn’t fully been taken out and we have Canada’s January CPI to contend with today.

NZD – strong retail sales overnight offer no fresh boost for the kiwi and AUDNZD is looking at possibly rejecting this latest surge lower below 1.0700... stay tuned. There’s further wood to chop to get NZDUSD bears on the prowl, but another leg lower below 0.7250 would quickly put the pivot of the recent lows and 200-day moving average around 0.7175 in the crosshairs.

SEK – Riksbank minutes today as EURSEK interacts with the key cycle resistance at 10.00.

NOK – EURNOK has gone fairly quiet, but we have a more clearly etched local downside pivot now just below 9.64.

Upcoming Economic Calendar Highlights (all times GMT)

   • 0830 – Sweden Riksbank Minutes 
   • 1000 – Eurozone Jan. Final CPI 
   • 1200 – UK BoE’s Ramsden to Speak 
   • 1330 – Canada Jan. CPI 
   • 1400 – Mexico Q4 GDP 
   • 1515 – US Fed’s Dudley and Rosengren to Speak on Fed Balance Sheet 
   • 1600 – US Fed Releases February 2018 Monetary Policy Report to Congress 
   • 2040 – US Fed’s Williams (FOMC Voter) to speak on US Economic Outlook 

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