Can US Employment Report Hold EURUSD Back From 1.40 Test?

 | Mar 07, 2014 06:47AM ET

The ECB did an ECB yesterday, with the bank's boss Mario Draghi talking perhaps even less dovishly than the last time around and surprising the markets once again with a big, loud “pass” on any new policy measures. The economic growth forecasts were even revised very modestly higher for 2014 and Draghi expressed confidence that there are no material deflation risks.

The market had priced in a dovish tilt, so the immediate reaction to Draghi’s initial statement yesterday was rather swift and brutal and EURUSD closed yesterday at its highest level since since late 2011, with only the odd, illiquid (and probably option barrier related) intraday high near 1.3900 barring the way to 1.40 and perhaps beyond as we only have the US employment report standing between us and the Fed meeting on March 19 and the possible need to wait for the April data cycle to know whether the weather (or the degree to which, haha) is the culprit behind the US economy’s soft data patch. On that note, see a piece put out yesterday from Seeking Alpha on the Fed “putting all of its eggs in the weather basket.” (Hat-tip: Steen). One thing for sure, if it emerges in April and May that the US economy continues to weaken, the Fed is going to have an egg on its face problem.

As for why the ECB did not move to stop the sterilisation of SMP bond-buying programme, one possible explanation comes from a Citi research piece suggesting that there might be the paradoxical risk from such a move that it could shrink the ECB’s balance sheet anew because it might have allowed the weaker banks to pay down their long-term refinancing operation loans (LTROs) ahead of the stress tests later this year. So the ECB may be thinking: interest rate cuts are too marginal and ineffective to be worth the bother, and it’s either go for full quantitative easing because of clear signs of strain in the banks or the economy, or do nothing. But unless the Fed is forced to move more aggressively to taper at coming meetings, the cost of doing nothing could mount quickly and set the path of the EURUSD toward 1.50. Two other issues that could certainly derail such a scenario in a hurry: one, a weakening in risk appetite, which seems to favour the USD more than EUR now, and two, a further escalation of the confrontation over Ukraine in coming months. I think the market has been far too quick to write off the latter issue — the main danger being Europe and the US failing accept Russia’s point of view on this issue.

Chart: EURUSD
EURUSD will need to maintain the breakout today through whatever the US employment report offers us later today if we are to keep the view toward 1.4000 and beyond going into the Federal Open Market Committee (FOMC) meeting on March 19. Only a close below 1.3750 or so today would negate yesterday’s powerful move.

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