Tuesday’s jump in Euro FX futures may have given hope to international bulls eager for a sign that the currency’s two-month slide vs. the US dollar had run its course.
At first glance, such enthusiasm is understandable. The 0.0126-point closing gain was the currency’s biggest one-day move since June, and the third-biggest of the year. It almost completely reversed the October 25 sell-off that took the December Euro futures contract (6EZ7) below a support level defined by the August and October lows, and it broke above a downtrend line connecting the September and October highs.
Next stop, new highs? Well…
Some traders who may have jumped on the bandwagon on Wednesday likely found themselves a bit underwater by the end of the day. Although the Euro popped to 1.1881, its highest level in almost a month, it ended the day with a loss and near the bottom of its range.
While past performance does not guarantee future results, there are two factors traders may want to be thinking about right now:
· First, the Euro futures haven’t performed particularly well right after big up days like Tuesday—as evidenced by Wednesday’s weak close and Thursday’s tepid trading. The Euro contract has closed 0.0100 or more higher 346 times since 2001, and five days later it was lower 54% of the time. For reference, 52% of all five-day periods in the Euro since 2001 have been up.
· Second, the Euro has a little problem called interest rates. The “price” of the Euro, after all, is the price of the Euro relative to the US dollar—the Euro/US dollar rate. When comparing any currency pair, the currency with the higher (or rising) interest rate will (all else held equal) be stronger than the one with the lower (or falling) interest rate.
For those keeping score at home, the US Fed funds rate (the Federal Reserve’s benchmark lending rate) is 1.25% while the European Central Bank’s (ECB) comparable “refi” rate is zero.
After years of easy money policy in the aftermath of the 2008 financial crisis, the Fed began raising interest rates at the end of 2015 and is widely expected to hike them again at the conclusion of its December 12-13 meeting.1 The CME Group’s “FedWatch” tool, which estimates the probability of a Fed rate change using the exchange’s Fed funds futures contract, currently has the odds of a 0.25% December rate hike at above 90%.
The European Central Bank (ECB), by contrast, is not expected to hike rates throughout 2018.2 The ECB is still engaged in the type of monetary stimulus efforts (buying financial assets to keep rates low and goose economic activity, aka “quantitative easing, aka “printing money”) the Fed concluded in 2014.3 In fact, in late October the ECB announced that although it would reduce the size of these asset purchases, it would maintain the program at least until September 2018.4 Your friendly neighborhood economist will tell you that government banks don’t hike rates when engaged in quantitative easing.
Of course, interest rates aren’t the sole determinant of currency levels—if they were, the Euro wouldn’t have rallied vs. the dollar for the first nine months of the year. Nonetheless, this factor could limit the currency’s upside vs. dollar, especially if the Fed continues to hike rates.
Right now, the Euro will likely have to close solidly above its October high to make a serious run at its September peak, let alone attempt to launch another leg of the previous uptrend.
1 CNBC.com. Fed minutes: December rate hike all but certain despite low inflation. 10/11/17.
2 Financial Times. Euro rally pushes chances of ECB rate hike to lowest on record. 9/4/17.
3 European Central Bank press release. Monetary policy decisions. 10/26/17.
4 CNBC.com. ECB unveils plan to cut, but extend, its massive bond-buying program. 10/26/17.