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FX Research2 .pdf

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FX Viewpoint: give EUR a break!
Deflation! Japan! Doom! – the headlines last week when the euro area inflation fell below 1%. Mind you, this is not
the euro area specific issue: disinflation is what has held Fed from tapering too. It is somewhat of a global
phenomenon, partly cyclical, but also structural*. December taper and December refi rate cut? Ehm…
Figure 1. EMU and US inflation decoupling…oh wait

Will ECB react? Draghi was not exactly wrong saying that “with low inflation you can buy more stuff” a few
months back. Indeed, lower commodity prices have contributed to increasing consumer confidence and purchasing
power over the past year – the low October CPI was also not least due to the rather sharp fall in oil and other
commodity prices since early September (Figure 2), especially in EUR terms. Inflation expectations are well
anchoredabove 2%, still, if you look at 5y5y inflation breakevens (2.2% from inflation swaps). This all fits well with
Draghi’s words last month: 1) “the present inflation rates are not unexpected”; 2)“real incomes have benefited
recently from generally lower inflation.”; 3) “We have to look at the medium-term assessment of inflation”.
Figure 2. Commodity prices have dragged inflation down

December refi rate cut from ECB has become a consensus story after last week’s figures. The EURUSD took
adjustment, and is currently “fairly” valued relative to the coincident market indicators, including the relative interest
rates. No reason to cut rates against the improved sentiment data, and rather positive bank lending survey last week.
Even labor market, lagging in the cycle, is beginning to heal (Figure 3). This week factory orders and industrial
production data from Germany on Wednesday-Thursday could help the EUR (Figure 4). The EURUSD supported at
1.3480, then 1.3430 (Figure 5). A test buy here. Risk reversals are attractive, still at a discount for the upside, e.g. for
3M calls vol 1% pt below puts.

Figure 3. EMU labor market – tentative signs of recovery

Figure 4. German industrial production – to pick up

Figure 5. EURUSD at the first line of support

Too far, too fast, the DXY (USD ) strength has gone last week, resistance just below 81.00 (Figure 6). The
expected pickup in UST 10Y yields did materialize with a 12bp rush, and has been key explanatory factor for USD
strength. Key risk/reason for continuation: payrolls on Friday, if come above 125k (consensus) and with upward
revisions for previous months. But so far it does seem like a corrective USD rebound with the downtrend intact. Even
though there is still a decent chance for strengthening to continue to close the September gap (81.50)… it does pay
to start positioning for a weaker USD vs Tier 1 majors with a several month horizon.

Figure 6. USD index hits resistance

The GBP has been victim of circumstances. No big changes in generally good data, but the surprise index has
been trending lower as hoped. The Bank of England policy meeting this week will come and go with no big drama.
The GBPUSD short has been performing well, finally taking a more decent turn down over the past week. Take profit
on 2/3…but keep the rest of the short with the stop-loss close to break-even or below (e.g. 1.6110). With a double top
pattern in the making (Figure 7), it’s just too tempting to participate if it breaks – potentially toward low 1.55s.
Figure 7. GBPUSD for a test

The risk sentiment is likely to deteriorate further in the coming days, so far orderly decline in stocks has not been
sufficient to push the USDJPY lower. Pending. The AUDUSD short, USDCAD long should also benefit as
commodity/oil prices decline too (still keep 1/2 of both). The Scandies are not the lucky bunnies in this, especially the
more liquid SEK…if you are worried about 0.7% y/y in euro zone…how about 0.1% y/y in Sweden! Note, EURSEK,
USDSEK hit important downtrends last week. Above there – won’t look back. Stronger first? Maybe (Figure 9).
Figure 8. EURSEK scratching LT trendline

Figure 9. EURSEK – déjà vu…


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