The ECB monetary normalization is not the only factor, putting a pressure on EUR/USD

 

Looking at the market response to the publication of the report on U.S. inflation, I recall the joke about two analysts:

- Do you understand, what’s going on?

- Yes, I will explain you everything...

- No, thanks! I can explain everything myself, but I can’t understand...

 

The experts, interviewed by popular mass media, explained USD index fall and the equity market closing the price in the green zone in response to the strong statistics on CPI and core inflation by several reasons: excessive increase in energy prices, clothing (bad weather), medicines (flu epidemic). The so-called temporary factors that will hardly make the Fed act aggressively. A good explanation, but what about the fact that the derivative market has increased the likelihood of  the federal fund rate rise in March from 78% up to 83%? CME derivatives raised the chances of four monetary restriction acts from 17.5% up to 26%?

 

In respect of previous terms, the U.S. dollar should grow stronger. In fact, the chances of the Fed monetary restriction are rising by the day, 10-year Treasury yields are renewing 4-year highs, and their 2-year counterparts has been near the top levels since the autumn of 2008. The more surprising is USD index weakness.

 

Dynamics of USD index and U.S. Treasury yields

Source: Bloomberg.

 

If the relation change, the market will change either. In this situation, it is necessary to change the world view, look for new drivers of growth, able to form a new concept of reality. The most simple approach is to look for the reasons of what’s going on outside the USA. The rapid growth of the global economy brings the monetary normalization by the central banks competing to the Fed closer and, in the situation of lagging economic cycle, allows EUR/USD pair to ignore the factor of the Fed’s monetary restriction. The same opinion is shared by most of more than 500 institutional investors, the participants of TradeTech FX forum in Miami. Some of them expect euro to rise up to the levels of $1.35 (Amundi), $1.4 (State Street) and even $1.43 (A.G. Bisset Associates) at the end of the year

 

The theory of the influence of budget deficit and foreign trade on dollar looks quite interesting. When the first one has expanded up to $176 billion (the largest difference with 2013)over the last four months of the fiscal year, and the latter, not including oil, has reached the highest level of $50 billion, it becomes more difficult for the USA to attract the money to fund them.

 

Dynamics of dollar and the U.S. deficit

Source: Bloomberg.

 

I personally prefer studying the concept of volatility, the sale of which in the times of ultra-soft monetary policy was a kind of funding. VIX growth irrespective of the Fed’s actions equals to the increase in money value and supports dollar strengthening. In this respect, the fall of CBOE volatility index below the historical average of 20 allows to explain EUR/USD rally in response to the strong statistics on the U.S. inflation. The pair’s future still depend on the ability of the U.S. stock indexes to restore the uptrend. If they will mange to, euro will cost $1.

 


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Dollar breaks the stereotypes

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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