Euro Bulls Look for French Voters to Seal the Deal: Macro Week

  • U.S. data, Fed talk under scrutiny as payrolls fail to excite
  • Super Thursday arrives for the BOE amid Brexit hard talk

JPMorgan's Cavenagh Sees Stronger Euro in 2H

The euro rose for a fourth consecutive week despite a hawkish-sounding Federal Reserve as the market discounted a win for centrist Emmanuel Macron at the French presidential run-off.

Dollar bulls must have been heartened to see geopolitical tensions with North Korea ebb, a U.S. government shutdown averted and House’s healthcare bill passed successfully. The market is now assigning a 75 percent probability of a rate increase in June, compared with 60 percent before the Fed met on Wednesday, based on overnight indexed swaps and the Fed funds effective rate. The employment report for April was mixed: while the expansion in U.S. payrolls beat the median estimate, the number for March was revised lower.

The euro’s resilience stood out, though. The common currency hit $1.0992 on Friday, its strongest level since the U.S. election. While it is true that the euro-dollar’s latest rally has been boosted by an unwind of euro shorts as the risks surrounding the French election recede, further upside could be justified by a continuation of the latest trend in economic data. Core inflation has finally picked up, while growth has maintained its upside momentum, with PMIs also printing on the stronger side.

European Central Bank Executive Board member Peter Praet reiterated the notion that risks to the outlook moved closer to balance while he noted that policy makers’ forward guidance is also concentrated around “sequencing, which gives indications about the expected path of our key policy rates during the life of our net asset purchases and beyond.”

As the dollar lost its post-U.S. election appeal, the outlook for the common currency remains constructive. Interest-rate differential spreads are narrowing, dragging euro-dollar higher as a medium-term bottom seems to be in place near the 1.05 handle.

If option pricing is anything to go by, an extended move north for the euro could come as early as next week. Demand for out-of-the money options relative to at-the-money ones signals increased expectations for the pair to trade a wider range next week, with the so-called butterfly on the one-week tenor having risen to levels not seen since the U.K. referendum in June.

Data from the Depository Trust & Clearing Corporation shows that expiries over the next 30 days are mostly concentrated below $1.08 as the latest rally has caught the market wrong-footed. A Macron win on Sunday could mean traders will have to chase price action higher at least in the medium term after the dust settles, while option traders could find themselves being short gamma on the move.

On the technical side of things, while short-term charts suggest upside exhaustion (DeMark TD Sequential has successfully completed a ’13’ sell countdown series on the four-hour chart), the weekly picture is bullish. The euro looks to close above its 55-weekly moving average for the first time since November while it looks to overtake the important 61.8 percent Fibonacci retracement of its drop since the U.S. elections. Momentum studies suggest that the move isn’t overdone yet, with further upside risks in place.

Euro bulls will be looking at data out of the U.S. and Fed speakers for cues on downside risks. The Fed minutes due May 24 may bear greater importance than they do usually. Given labor and inflation prints will have come out by then, their tone could be "make or break" for a June rate move.

What to Watch

  • While all eyes on Sunday will be on the French vote, a state election in Germany this weekend could also gather interest as Chancellor Angela Merkel builds up her campaign for a fourth term in September.
  • Fed’s Mester opens Monday a series of speeches by policy makers due next week, with the line-up including among others Bullard, Kashkari and Dudley. Mester was an advocate for higher rates through much of the second half of 2016, and her comments could weigh on the greenback should she sound reserved on a June rate increase
    • U.S. consumer prices and retail-sales data come out Friday; economists project inflation probably rose in April, keeping its gradual yet slow build-up
  • The BOE, which meets Thursday, is expected to keep its policy mix unchanged. It will also update its forecasts on growth and inflation, which could be pivotal for the pound’s flirt with $1.30 handle
  • On the same day, the European Commission will publish its new economic forecasts, while the RBNZ is seen as leaving its official cash rate target unchanged at 1.75%
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