By; Rodney Hunter
Dealing with the financial aspect of the deep-shallow trading from quarter 1, the Euro convinced the traders that its speed of rates are conducted with the dollar. In normal times the driving factor would be the relative economic performance of the US and the EURO area, as reflected in the official interest rates decreed by the federal reserve and the ECB. Thus a boom in the EUR appreciate, at which point the ECB may raise rates. Two things dominated the financial world this 2018: political turmoil and fears of slowing economic growth. The first was quite foreseeable with Brexit and Trump's victory in the US but the second dawned on markets like a cold shower in the second half of the year.We see that in the data with manufacturing activity in the US exceeding expectations when everyone else misses. In other words, President Trump's trade tantrums hurt everyone else more than the US, which is part of the reason why the US dollar is up across the board today.
It was not long ago when EU's growth hit record highs, according to Markit, with business activity shrinking to its lowest pace of growth in over four years in December. Housing has been a particular weak spot in the US economy over the past year, but the recent decline in US rates could prove to be a stimulant to the sector. Germany which is the core of the European economy, remains highly vulnerable to manufacturing slowdown which itself is roiled not only by cyclical but secular factors. A massive part of German economy – and European manufacturing sector as well is dependent on car production which is going through wrenching changes and existential threat from electric vehicles. It’s difficult to imagine that Europe will see any rebound in manufacturing any time soon and the region’s best hope for growth remain in services where the demand appears to be more stable and stronger. The European Central Bank has been on the defense for most of the year, warning about these very same risks and unless US-China relations improve over the next few weeks, they won't have anything good to say when they meet in April. Concerns about future activity are so elevated that investors completely shrugged off President Trump's decision to delay auto tariffs for 6 months. This temporary reprieve sets up for a tense period of negotiations with Japan and the Eurozone.The Federal Reserve was the primary central bank raising interest rates last year but that will change as other countries move to normalize monetary policy more aggressively. At the beginning of 2018, the Fed said they would raise interest rates four times.
This year, they are telegraphing somewhere between 2 to 3 rounds of tightening after expectations were downgraded this past December. Now the Fed will still be raising interest rates in the first half of the year, which could lend support to the dollar but as the central bank makes it clear that less tightening is needed, the greenback will flounder. At their last meeting, Fed Chairman Powell told us that no future rate decisions are predetermined and everything is data dependent. This tells us that if the economy continues to slow, they’ll delay raising interest rates.
The implied euro volatility tends to rise now as the euro falls. Three-month implied volatility recorded a five-year low near 4.80% in the second half of April. When the euro recorded its low on April 26, vol briefly traded above 6%. During the consolidative/corrective phase here in May, the implied volatility has eased back to 5.3%. Given the overall tone of the most recent FOMC statement and the amount of time since his last Congressional testimony, we believe that Fed Chair Powell will spend a good portion of his time on Capitol Hill explaining why the central bank believes that the case for a rate cut increased significantly over the past few months. Back in February, the Fed was still thinking about tightening, the labor market was strong and Powell said the outlook for the economy was positive. Last month, the central bank dropped the word patient from their policy statement, said uncertainties increased and saw 8 FOMC members forecast a rate cut this year. July easing seems like a done deal but the price action in the US dollar suggests that forex traders are ill prepared for negative comments from Powell on Wednesday. They hope that the better than expected employment report will push a rate cut to September or give the central bank the confidence to signal that a cut in July is all that the economy needs this year. Those who argue that the US will avoid a sharp economic fall point to the strong labor market and positive consumption data. With over 70% of GDP derived from this critical sector, jobs underpin American consumption. An extraordinarily strong hiring cycle has attracted new workers into the labor force, which has increased incomes and expanded the consumption base.
If you also factor in the positive trend in wage growth, you have a compelling story for a soft economic slowdown that will avoid recession. However, the problem with having an ultra-strong labor market that has seen monthly job gains of over 200K is that it would not take much for companies to begin slashing payrolls due to perceived negative signals. The US employee psyche has been scarred by the extended hardship of the financial crisis, and if the media and data light up to HR cuts, US consumer would quickly move into a defensive position — lower spending.
Twelve months after Congress cut business tax rates and sped up deductions to set off a capital spending boom, the results are proving modest at best. A broad measure of business investment surged earlier in the year, but slowed since. It swung in part not because of tax policy, but in line with shifts in energy prices. Moreover, shipments of capital goods have tailed off after rising robustly early in the year and industrial capacity is rising modestly. Growth in business investment, a key element of economic expansion, rose after last year’s tax overhaul, before slowing again. The tax package did not stimulate or spark a boom in business investment. The Trump administration put a business investment boom at the core of its tax-policy agenda, and Republicans say they designed the law to spur a sustained increase in economic growth. US economy may grow 3% in 2018, faster than its pace through most of the expansion. The tax law’s authors have hailed the solid growth and shrinking unemployment, but the economy’s ability to sustain that pace hinges on the path of business investment.
Long story short, EUR/USD testing critical multi-year slope support – bears vulnerable above 1.1186. The Euro is down more than 0.4% this week with price now testing multi-year slope support late in the month. These are the updated targets and invalidation levels that matter on the EUR/USD weekly price chart. Euro has been unable to mark a weekly close below the lower parallel of the broad ascending pitchfork formation we’ve been tracking off the 2015 / 2017 lows – the focus is on a reaction off this threshold with the bears at risk while above the 61.8% retracement at 1.1186. A break / weekly close below would be needed to keep the short-bias viable targeting 1.1107 and former channel resistance, currently around ~1.1050. Resistance steady at 1.1393 with a breach above the yearly open at 1.1445 needed to suggest a larger advance is underway targeting 1.16.
Euro has been testing this slope support since mid-April and leaves the immediate short-bias vulnerable. From a trading standpoint, a good place to reduce short-exposure / lower protective stops – watch the weekly closes for guidance. Look for downside exhaustion ahead of 1.1186 IF prices are going to hold this slope with a breach above 1.1445 needed to shift the broader focus higher.
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