– EUR/USD retraces back to former support level near $1.0807.
– AUD/USD may come under more pressure as risk sours.
An important shift happened in FX markets starting two weeks ago. Before October 22, the calculus was very much that the Federal Reserve would be keeping its rates on hold through the end of 2015 (hawkish hold), and that the ECB wouldn’t be cutting rates or expanding its QE program (dovish hold). Relatively speaking, Fed and ECB policy was converging.
Since the ECB’s October 22 meeting, and especially since the start of November, Fed and ECB policy has been diverging – rapidly. With the ECB openly discussing cutting rates in December, and now that the Fed is armed with an exceptionally strong US labor market report, market expectations for the stimulus horizon have been turned on their head.
If one caveat of Fed and ECB policy converging in the middle of the year was higher EUR/USD prices, which in turn, led us to the belief that, reflexively, a stronger than expected EUR/USD could provoke ECB easing; then we must also suggest that, reflexively, a weaker than expected EUR/USD could diminish the need for additional stimulus.
As market participants price in ECB action in December, it’s worth considering that EUR/USD is now trading below its forecast figure provided in the ECB’s September staff projections. With Euro-Zone economic data – notably inflation and PMI readings – starting to turn the corner, any further EUR/USD downside may diminish the need for a substantial easing package in December.
How does this all relate to the US Dollar? If the ECB doesn’t see the need to deploy its ‘big bazooka’ – another deposit rate cut alongside an enhancement to the QE program – and US economic data proceeds smooth enough to allow for the Fed to raise rates, then the risk environment may be mispricing assets like the commodity currencies. In that case, pairs like EUR/AUD or EUR/NZD may not see that much further downside; and pairs like AUD/USD and NZD/USD could resume their year-long downtrends.
— Written by Christopher Vecchio, Currency Strategist
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