Talking Points:
- EUR/USD rallying stalling a bit as market shies away from ECB.
- USD/JPY taking a breather despite Nikkei's near -5% drop.
- As market volatility rises, it's a good time to review the "Traits of Successful Traders" series.
Given recent commentary from Federal Reserve officials, including from Fed Chair Janet Yellen at her two testimonies this week, the US Dollar needs its highest-rated economic data to start to turn here in order for future rate expectations to firm up; currently, zero rate hikes are being priced in over the next year, per the Fed Futures contract. In fact, markets now think there is a greater chance of a rate cut than a rate hike at the March FOMC meeting.
Table 1: Fed Funds Futures Contract Implied Probabilities: February 12, 2016
Deteriorating rate expectations have been the prime driver of US Dollar weakness in 2016, a development that we had been anticipating as early as the week of the Fed's December 16 policy meeting. Coming into this year, Fed funds futures contracts were pricing in a 11% chance of the Fed raising rates four times as the FOMC's December 2016 SEP projected. Now, markets are only pricing in a 11% chance of a rate hike this year at all.
Chart 1: December 2016 Fed Rate Implied Probabilities
There is a chance markets may have gotten ahead of themselves. Recent updates to the Federal Reserve Bank of Atlanta's GDPNow growth tracking index are suggesting that Q1'16 is on pace for a +2.5% annualized rate.
One thing to consider moving forward: the EUR/USD exchange rate. A stronger EUR/USD makes the price transmission mechanism in the Euro-Zone slower, which is becoming problematic for the European Central Bank now that the spot rate is rising above the ECB’s NEER.
Chart 2: EUR/USD Spot versus ECB’s EUR/USD NEER (August 3, 2015 to February 3, 2016)
With the ECB’s 2016 technical assumption at $1.0900, the max closing level this week in the spot price has thus far been +3.87% above the EUR/USD NEER. Ahead of the ECB pre-announcing its deposit rate cut at its October meeting, EUR/USD had closed as high as +3.37% above the ECB’s technical assumption for 2015 (at the time: $1.1100). It's time to start becoming a bit more skeptical about the Euro up here - trusting the ECB to keep quiet up here seems like a bad bet. EUR/CAD (as explained in the video) may be a reversal candidate in its multi-month uptrend.
See the above video for an expanded conversation on the fundamentals underpinning the US Dollar and for technical considerations in EUR/USD, USD/CAD, AUD/CAD, USD/JPY, EUR/GBP, and the USDOLLAR Index.
Read more:USDOLLAR Index Flirting with Break; BOJ Meddling in JPY
--- Written by Christopher Vecchio, Currency Strategist
To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com.
Follow him on the DailyFX Real Time News feed, Twitter, and Stocktwits at @CVecchioFX.
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