After a still start to a year, we were anticipating for a some-more sparkling final few months of 2016. Sure enough, Q4’16 finished with a ‘bang.’ The stretches of low sensitivity seen in EUR/USD during Q2’16 and Q3’16 gave approach to poignant cost developments in Q4’16, catalyzed by executive banks and domestic developments on both sides of a Atlantic. Going forward, a factors that led to EUR/USD violation by a Mar 2015 cycle low in Q4’16 will expected contend their change into Q1’17.
On a US Dollar’s side, a preference in Dec 2016 to vigilance 3 rates in 2017 – as opposite to a market-priced dual brazen of a process matter – has sent US Treasury yields higher. As a sign of long-term expansion and acceleration expectations, a US Treasury produce bend steepening is a thoughtfulness of a market’s faith that tighter financial process is entrance in a near-term.
The categorical reason because US Treasury yields have been going aloft has to do with a thespian change in marketplace expectations for US mercantile policy. Given a expectancy of a Democratic Clinton feat with a separate Congress, some-more gridlock in Washington DC – and so some-more mercantile recession (‘continuation’ as we called it in a Q4’16 forecast) – was anticipated. However, with a Republican Trump feat and Republican brush in Congress, marketplace participants cruise gridlock might retire to a pages to story (‘disruption’ as we called it in a Q4’16 forecast). In a 18 years given 1965, when one celebration has tranquil both Congress and a White House, a US constructional bill necessity has increasing by +0.4% per year. Budget deficits tend to be inflationary, that if in spin translates into a some-more hawkish Fed, EUR/USD should have a reason to continue lower.
On a Euro side, a European Central Bank’s preference in Dec 2016 to change a QE module valid significant. In a Q4’16 forecast, we pronounced “The ECB will really expected be forced to mislay a -0.40% separator (allowing some-more German bunds to be purchased), or to mislay a collateral pivotal reduction (allowing some-more marginal emperor debt to be purchased).” By going a former track as opposite to a latter, a ECB has primed a Euro to be in a difficult position if seductiveness rates elsewhere continue to rise.
Previously, produce curves in Europe were flattening as investors front-ran ECB bond-buying: with a ECB observant it wouldn’t buy debt with yields to majority below a deposition threshold of -0.40%, there was a nonesuch outcome along a produce curve. This is no longer a box now that a ECB will buy holds during any YTM, that reduces a need for investors to buy holds during longer tenors down a curve. Concurrently, with a preference to buy 1-year debt, a ECB has signaled that it is altering process to keep a front-end of European produce curves pinned as low as probable – even in increasingly disastrous territory.
On a surface, both US Treasury and German Bund produce curves are steepening – though they are doing so for really opposite reasons. With a UST produce curve, it is a outcome of both short- and long-end yields using higher, though with longer-dated holds display a crook boost in produce – a bear steepener. With a German Bund produce curve, short-end yields are descending faster than long-end yields are rising – same to a longhorn steepener.
Chart 1: EUR/USD contra German-US 2-year Yield Spread (June 20 to Dec 19, 2016)
In a initial week of November, when EUR/USD traded nearby 1.1140, a German-US 2-year produce widespread was roughly -145-bps. At a time this news was created (the week of Dec 19, 2016), with EUR/USD trade nearby 1.0420, a German-US 2-year produce widespread was -205-bps. The 20-day association between EUR/USD and a German-US 2-year produce widespread was +0.833, confirming a stress of attribute during benefaction time. In conjunction, these twists and shifts in a US Treasury and German Bund produce curves have pushed out a German-US 2-year produce spread. This will be a many critical cause to watch for EUR/USD going forward, quite as a attribute between yields and EUR/USD appears to be such a poignant motorist (if a widespread were to dilate another 50-bps to -250-bps, afterwards EUR/USD could trade nearby 0.9500, for example).
By a finish of Q1’17, traders should start to compensate some-more courtesy to European politics. On Mar 15, 2017, a Dutch elections will be held, a initial of 4 poignant elections in 2017. After a thespian ‘No’ outcome on a Dec 4 inherent referendum, Italy will expected conduct to a polls again by mid-2017. Luckily, for a Euro, a miss of remodel that cost Matteo Renzi his pursuit as primary apportion might keep a Italian domestic complement damaged adequate to forestall a Five Star Movement from ever achieving adequate energy to lift Italy out of a European Union. In Apr and May 2017, French presidential elections will be held, and a nation will face a possess populist hazard in Marine Le Pen. Later in 2017 (date TBD), German elections will be hold amid an sourroundings in that Angela Merkel’s recognition Is fast shifting (at five-year lows in Dec 2016) interjection to her immigration process and an stretched terrorism hazard in Europe. Needless to say, for those who suspicion 2016 was a year of surprises and shocks, 2017 is certain not to disappoint.
Technicals: EUR/USD Turn Lower
We were looking for signs of a spin aloft in Q4’16, though that didn’t happen. Instead, EUR/USD pennyless reduce in a poignant way. In a Q4’16 EUR/USD forecast, we wrote about a intensely coiled sourroundings sustaining in a pair, noting, “according to a measure, EUR/USD is a many coiled in history. It’s been 81 weeks given a final 52-week high or low. The prior record was 77-weeks, that finished with a dermatitis in May 2002.” Furthermore, “if a Mar 2015 lows break, afterwards a call for a bottom is wrong and concentration would change to 0.9450-0.9550 (historical rhythm indicate and totalled objective).” This section is in play in Q1’17 and is reinforced by a 61.8% retracement of a 1985-2008 convene during 0.9608.
The underside of a 1985-2000 trendline, that pennyless in November, should be watched for insurgency in Q1’17 entertain in a mid-1.0900s. With that line broken, it’s value following parallels of a line that extend off of a 1995 and 2008 highs. The together that extends off of a 2000 low is nearby 1.0100 and should be watched for support. The low done after a Dec FOMC is a 1997 low. That turn did mangle eventually though not but substantial onslaught (circled on a chart). Something identical (back above 1.0900 before an try lower) wouldn’t be a warn given a mania with parity.
Strength by a median line from a bearish channel, that was insurgency via 2016, would trigger a vital bearish trap and change concentration to a downtrend line in a mid-1.2000s after in a year (fitting with a thought of a US Dollar rising afterwards descending over a march of 20170.
Written by Christopher Vecchio, Sr. Currency Strategist and Jamie Saettele, CMT, Senior Technical Strategist for DailyFX.com
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