Caution Needed: ‘Draghi In Mirror Is Closer Than He Appears’

In our week ahead preview, we spent considerable time talking about the dollar dynamic as it relates to this Friday’s CPI print. For those who missed it, here are the key passages:

What we got on Friday following NFP seems to suggest that the “USD risk remains skewed to appreciation” – as Barclays puts it.

That said, the knee-jerk move lower after the Mueller headline hit on Thursday afternoon underscores the extent to which bearishness remains firmly entrenched and prone to manifesting itself in the price action at a moment’s notice and on any excuse. It’s the same dynamic in Treasurys.

This is of course playing out against a backdrop that’s seen the euro push relentlessly (until Friday) towards 1.20. This morning, euro strength was coming off until about 3:45 a.m. when EURUSD jumped as much as 0.4% to 1.1814, bouncing from 1.1766 day low amid what traders simply called “broad demand.”

EURUSD

You’re reminded (and this is critical) that the reason you’re seeing this is that traders are starting to doubt the extent to which the policy divergence theme is going to look anything like everyone assumed it would look going into the year.

With the Trump agenda D.O.A., the data coming in solid in Europe compared to still lackluster inflation (and underwhelming hard data in general) in the U.S., and with Draghi looking at an exit strategy, it’s no longer clear that it makes sense to think Fed balance sheet normalization will trump (no pun intended) policy uncertainty in Washington, improving fundamentals in Europe, and a hawkish ECB.

Still, the euro has run out ahead of the rate differentials pillar:

RateDiff

All of this ahead of Jackson Hole or, as we like to put it, “Draghi in mirror is closer than he appears.”

More below on all of this from former trader Richard Breslow…

Via Bloomberg

It’s been really quiet this morning, which seems entirely appropriate. Volumes are running well below normal and, for the data dependent, it’s a light week with the important U.S. inflation data not coming until the end. There’s always a danger in reading too much of anything into events when activity and news are so subdued, but it’s worth asking the question whether Friday’s non-farm payroll number and subsequent price action has changed anything. The answer is no and yes.

  • No, because none of the issues pressuring the dollar, and keeping rates subdued have been resolved. On the other hand, yes, because this is the first time since these latest moves became impulsive that dollar sellers got hurt.

Dollar

  • Unlike the famous Mike Tyson quotation, once traders get punched in the mouth they realize that they now need a plan. The path of least resistance suddenly isn’t completely painless
  • We always knew, or should have, that it would be heavy going the whole way from 1.19 through 1.20 for EUR/USD. But while the resistance was respected all of last week, it didn’t seem to daunt traders who kept nibbling near the highs. Don’t forget, we went into NFP at 1.1880. Which didn’t leave much margin for error. So now, in addition to multiple historic data pointing to this area as technical resistance, we have renewed proof
  • Investors and, I suspect, reserve managers continue feeling better about the euro zone and skeptical about the U.S. Of late that’s been a winning bet. It’s important, though, to keep updating your observations. There’s a lot of subjectivity to that assessment and it needs to be constantly questioned. If the utter non-reaction to today’s weak industrial production report from Germany is anything to go by, the euro is so far still being given the benefit of any doubt.

Germany

  • One data miss just doesn’t take precedence over debt ceiling concerns. But perceptions, like economies, move in cycles
  • This latest move has had an element of weak dollar to it, but also strong euro. The key to trading going forward will be to inform your EUR/USD view by how the shared currency does against its other crosses. If those moves begin to run out of steam, become cautious. I’m watching to see if EUR/CHF can comfortably stay above 1.14 and EUR/JPY above 129. If these levels don’t hold then we’re likely back to a period of two-way action
  • Aside from that, listen for any signs of ECB pushback on currency strength. I’d be surprised. Also keep an eye on how Jackson Hole begins to get handicapped as it becomes more imminent. And don’t assume Friday’s CPI is guaranteed to be more of the same
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