Europe as a Theater of War Operations

Most analysts who waited for a stable movement of euro rate to parity with dollar did not expect such a long-lasting active resistance
Finally, the past week satisfied dollar followers and turned out to be the best for its index (since September 2011). Those are FRS confident position in the assessment of the US economy in the 2nd quarter, the highest (since January 2013) growth of core inflation by 0.3% m/m, and a more clear Yellen's statement regarding possible adjustment of rates in the current year that are to be thanked. Derivative market assessed the chances for rates in September as 27%, although as back as one week ago, nobody wanted to speak about it.

Still, the main factors that can take away dollar growth are tied up to the condition of the American economy. In totality, price statistics, in fact, came out as quite average. Yes, we have some positive, prices are going up; however, in order for euro to drop, this dynamics is not sufficient. Regular market settings for an event got activated. The fixed income securities market, nevertheless, includes bad reports into the price. Now, even if FRS does not raise rates this year, USD decline against G10 currencies will be quite limited. Such drastic fall of main currencies looks quite speculative and out of place.

Most analysts who waited for a stable movement of euro rate to parity with dollar did not expect such a long-lasting active resistance. After the March many-year min (1.0496), the pair consolidated almost by 1000 points (max 15 May 1.1467) within 2 months.

The reasons for euro growth were:

  • Decline of interest to risk assets because of growth of yield of key countries' state bonds;
  • Weak data with regard to the USA (however, they were adjusted later);
  • Change of forecasts regarding FRS rate increase dates;
  • Technical factors of chronic repurchase and requirements for serious adjustment.

Such drive almost frustrated ECB plans that need steadily weak euro and controlled profitability, otherwise high indicators affect real loan rates and suppress economic activity. ECB had to use even verbal interventions (they were very successful, by the way). Draghi used his comments to put continuous pressure on the development of stimulus program; however, he was not able to stop growth. Then he had to put his colleague, Executive Board member Benoit Coeure, on the stage, who threatened to increase stimulation volumes last week, which produced the predicted effect of chain sales. The ground for that was not so much concerns regarding bond yield, but rather concerns regarding the scope of expected summer volatility against the background of regularly low liquidity, and, as a result, that will expect certain response measures from ECB. In the result of that, euro dropped more than by 400 points only within the last week.

Let's mention the main areas of "warfare" in the Eurozone:

Great Britain. It is the main (after Greece) big problem for Europe. Germany is getting used to Camerons' victory at the election, although with a difficulty. Unexpectedly for themselves, the EU recognized that the fact of referendum regarding leaving the Union is quite a real perspective of the following year now. It is exactly on German initiative that an active support of the whole EU system reconciliation with private British demands is underway now. A perspective of a "large deal" (an international agreement outside of EU structure) by three parties with the purpose of satisfying all interest is rising: Germany - more power over budget politicians; France - more investments; and the countries outside of euro circulation (Sweden, Denmark, Poland, and Great Britain) - a new set of benefits and protection from any attacks on the part of the Eurozone.

Greece. Active blackmailing regarding Athens possible failure to make the IMF payment due on June 5 continues. It is possible that Greece will find money for one payment; however, the further plans are all gloomy. Analysts assume that Greece may even be late with the payment to see the creditors' reaction. There are no decisions with regard to improvement of financing in the framework of aid provision. What we have is complete absence of progress at negotiations in Riga. New rumors have appeared that Germany admits the possibility of introduction of a "parallel currency" in Greece along with euro, which may be an intermediate stage in the country's pull out of the block. Nevertheless, most members of ECB Board agree that new accords are quite feasible - it only Greece accepts the new level of total control. There is no other way to do it; otherwise it will end in a default. However, we should not speak about any default now; borrowers and insurers' sentiments (CDS) are on quite tranquil levels.

The news block of this week contains information that can give new signals regarding the US economic activity. A part of indicators have confident positive predictions for dollar: Conference Board consumer confidence index, weekly applications for unemployment benefits, Chicago Managers' Indices (PMI). The publication of the second US GDP assessment for the 1st quarter (May 29) may become an event, Wall Street Journal prediction - drawdown by 1% q/q, which will be the worst result for the last year. We should also take political events into consideration - G7 meeting will start on Wednesday. The Eurozone statistics will offer only the European Commission report for May and consumer demand predictions for Germany and France.

The main sentiment for the main currency - only downward despite the fact that players' bullish sentiment with regard to dollar is becoming weaker (according to CFTC data). A penetration below 1.1000 level actually took place on Monday - option barrier was executed and large stops were activated at penetration. For now, further decline is restrained by American and, to a lesser extent, by European demand, which is unspent because of yesterday's weekend. If EUR/USD hangs below 1.1000 strike level for a long time, we will have to wait for working out of Put range 1.1000 – 1.0800. A large number of buyers from 1.1000 hang with open positions and, in order to avoid losses, they will try to purchase at least to that level, which will allow either to sell on the approach to 1.1060 or buy above a new penetration.

Author: Navsher Bartash,
ForexChief Currency strategist