EUR/USD Rose Because ECB Pushed Rate Change into Mid-2020, While Fed May Cut Before That

James Hyerczyk
Updated
For months we talked about the divergence in monetary policy driving the U.S. Dollar higher against the Euro. Now it looks like the ECB may be in the drivers’ seat and this is what may have been underpinning the EUR/USD.

It’s nice to read recaps of the European Central Bank monetary policy announcements and ECB President Draghi’s press conference, but when they don’t tell you why the Euro rose against the U.S. Dollar, or give a little hint as to what it means to the near-term direction of the single-currency then I feel cheated.

Once again the headline writers had a field day confusing traders. “ECB Provides Dovish Outlook”, “ECB Leaves Rates Unchanged”, “ECB Guidance is Not Tilted Toward Rate Hike”.

How about these? “ECB Pushes Out Rate Hike …”, ECB Raises Prospect of Rate Cut” and “ECB Rules Out Rate Hike, Opens the Door to More Stimulus”.

So on paper it looks as if the Euro rose against the U.S. Dollar on Thursday because the ECB was dovish? No, that can’t be right. The Euro rose because the ECB opened the door to more stimulus. Not sure about that one either. Pushing the rate cut into the future must be the reason. Getting closer.

Why the Euro Rose on Thursday?

After careful analysis of the price action and the markets that primarily influence the direction of the Euro, I have to conclude that the Euro rose on Thursday because Euro Zone bond yields rose. Once again the bond market dictated the direction of a currency. What an unusual concept. (Sarcasm). And why is this? Because starting with the U.S. Treasury bonds and working down to other domestic bonds, bonds and bond yields control the markets. They are the measure of risk that investors want to take.

So why read the headlines, just watch the yields. Makes sense to me.

What Drove Euro Zone Yields Higher?

Investors sold Euro Zone bonds, making yields rise after Draghi announced that the three main rates would remain unchanged (as expected) at least through the first half of 2020, extending the ‘’patient” forward guidance period, from “the end of 2019”.

The bond market price action also suggests that investors may have been looking for a more dovish message. Perhaps they had priced in a rate cut before the end of the year. When they didn’t get what they were looking for, they adjusted their positions to reflect the delay into the first half of 2020.

So Now the Fun Begins

After preaching “patience” since December, Fed Chairman Jerome Powell said on Tuesday that the Federal Reserve will respond “as appropriate” to the risks posed by a global trade war and other recent developments. Traders seemed to think that this opened the door to the possibility of a rate cut.

In his remarks, Powell did not include a reference to the current Fed target interest rate as appropriate, or repeat the pledge to be “patient” before raising or lowering rates again. Both were standard talking points in recent Fed statements.

So while Powell was suggesting to be ready for a change, Draghi said essentially wait until mid-2020.

For months we talked about the divergence in monetary policy driving the U.S. Dollar higher against the Euro. Now it looks like the ECB may be in the drivers’ seat and this is what may have been underpinning the EUR/USD.

So if we look even further at the price action in the Euro Zone and U.S. bond markets, a tightening of the yields will continue to support a higher Euro, and a widening of the interest rate differential will be bearish for the EUR/USD.

We’ll know more on June 19 when the U.S. Federal Reserve announces its interest rate decision and releases its monetary policy statement. If the Fed cuts then the EUR/USD will soar. If the Fed holds rates steady then this is also likely to support the EUR/USD.

Somehow, if the Fed ends up on the same timeline as the Fed and continues to hold rates steady then investors will have to toss a coin, or perhaps pile into the currency which has the strongest economy.

This article was originally posted on FX Empire

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