Recap

Main Items:

  • US Consumer Confidence improved to 70.8 in Jan vs 63 exp and 61.1 prev. Apparently, the recent increase in gasoline prices was not enough to offset the good news from the labor market. Note that the “Jobs are Hard to Get” measure has dropped to the lowest level since 2008:

  • US Capital Goods Orders, Nondef Ex Air dropped -4.5% in Jan vs -1.3% exp and +2.9% prev. Headline DGO dropped -4.0% vs -1.0% exp and +3% prev. Note that over the past few years, DGO has had a strong tendency to decline after the end of each quarter, only to rebound in later months. As a result, the market is likely taking this print with a grain of salt. The US ISM print on Friday will be a much more important indicator of US economic momentum.
  • The ECB is temporarily suspending Greek debt eligibility as collateral as a result of the PSI, as expected. The ECB expects no liquidity disruptions as a result of ELA support.
  • The Irish Prime Minister said he wants to hold a referendum on the EU fiscal compact. The latest polls suggests a small but statistically significant plurality of ‘yes’ voters.

Overseas:

  • EU Industrial Confidence improved to -5.8 in Feb vs -6.9 exp and -7.2 prev. However, Services confidence worsened to -0.9 vs -0.6 exp and prev.
  • German GfK Cons Confidence improved to 6 in March as exp vs 5.9 prev
  • German CPI increased to 2.5% YoY in Feb vs 2.2% exp and 2.3% prev

Upcoming Data:

  • Japan PMI, Swiss KoF LEI, EU CPI, Swiss CPI, Global PMI’s

Commentary:

The upcoming ECB LTRO has been the subject of a great deal of virtual ink over the past few days. Most estimates appear to be ~500bn, and there are wide ranging debates regarding whether a larger or smaller number will be bullish or bearish for the EUR. I have no idea how it will play out, but given the amount of discourse over the subject, resulting price movements may be underwhelming. However, this may now be a good opportunity to think about possibilities for EURUSD for the remainder of the year.

As the chart below shows, over the past couple years, movements in EURUSD (white) has closely tracked 2 variables – the German-US interest rate spread (red) and the EU bank risk premium, as proxied by the Itraxx 5y Senior Financials CDS index. (purple, inverted)

This raises the question of where the underlying drivers are likely to go from here. The most plausible answer to that, however, is not very far from here. Let’s start with the rates differential. Given the fiscal & growth problems on both sides of the Atlantic, the likely evolution of central bank policy is likely to be both gradual, and dovish. This is a factor that appears broadly priced in to yields. Not only has the 5y yield differential bounced around 0 since last Sept, rates in both regions have completely ignored improvements in the data flow over the past few months. The fact is that with term premiums at already such low levels, the next large move in the German – US rate differential will be driven by whichever market sees their yields increase first. Given that central bank mandates higher policy rates only in response to higher inflation, and given that the ECB’s only mandate is price stability, a commodities driven price spike is likely to continue to be bullish for the EUR, if only because German yields are likely to have a higher beta to that. On the other hand, the EUR bank risk premium appears to only have limited room to fall from here. Even if the Itraxx index somehow falls to 2010 levels of ~150, there is at most another 50bps of downside, and it will occur only gradually. Therefore, if we make the very big assumption that the EURUSD cross continues to be driven by these two factors, the outlook for EURUSD is for it to be broadly range bound, with tail risks on both sides.

Shorter term, however, there may be a correction. Over the past week, rate differentials and credit spreads diverged for the first time since last November. Furthermore, sell side strategists remain EUR bears. While consensus expectations usually track a moving average of the cross, wide divergences between spot and forecasts have sometimes triggered corrections or a pause in the move:

NB: Of course, there are more than 2 factors that drive the EUR, and new factors become relevant all the time. Over the past decade, the average annual EURUSD range has been 22 (!) big figures. As a result, if history is any guide, we may only be at the midway point of the range for the year.

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