Daily Commentary: USD Gaining On Solid Fundamentals

 | Jan 10, 2014 01:10AM ET

The USD is clearly reacting to strong US economic news, contrary to what was happening late last year. This confirms to me that the rally in the EUR/USD in December was seasonal and probably influenced by repatriation by banks ahead of the Asset Quality Review this year. Thus yesterday’s action makes me even more confident in my bullish view on the dollar in 2014.

The euro yesterday failed to rally even after German factory orders exceeded expectations, Eurozone retail sales rose the most in 12 years and peripheral bond yields continued to decline, signaling increased confidence in the region. By contrast, yesterday’s ADP employment report was even stronger than anticipated and encouraged those market participants who are expecting strong growth from the US this year. The 10-year Treasury yield gained 5 bps and the implied interest rate on 2016 Fed Funds futures added a sharp 9 to 13 bps. Subsequently the minutes of the December FOMC meeting added little to our knowledge of Fed thinking beyond what outgoing Chairman Bernanke had said at his press conference following the meeting. Nonetheless the dollar continued to move higher, albeit slowly, and this morning in early European time it’s higher than it was this time yesterday against all the G10 currencies except the pound. GBP was the best performing G10 currency yesterday after the Bank of England said mortgage availability increased in Q4 last year and will continue to rise as the government’s plan to help first-time buyers improves access to mortgages. The dollar has also gained against most of the EM currencies we track too.

During the European day, BoE and ECB hold their monetary policy meetings. The market expects no changes from either bank, so the focus will be on the press conference held by ECB’s President Mario Draghi and his comments about taking any action the following months if necessary, especially after the slowdown in Eurozone’s CPI figures on Tuesday. The EUR/USD tends to be quite volatile on days when there is an ECB meeting even when there is no change in policy – almost twice the normal volatility last year -- and I would recommend caution in taking positions ahead of the meeting or indeed immediately afterwards.

For example, last June there was a 1.8% daily range on the EUR/USD on the day of the ECB meeting even though they made no change, the same as the range in November, when they did surprise the market with a change (although admittedly that was the most extreme example of the year – the average range on ECB days was 1.3%.) My expectation is that once again Draghi says that they stand ready to take further measures than necessary, but given his recent statements I’d expect him to stress that the economy is moving as they envision and they do not see further steps as necessary at this point. That could give EUR some temporary support and provide opportunities to establish new short positions. As the graph shows, on average the EUR/USD last year tended to move higher on days when there was no change in policy, and it rose significantly following the December meeting (although that may have also included year-end factors as mentioned above).