The EURUSD started out on a positive note as last weekend's G-7 statement was not strong enough to produce widespread selling. Although altering their official statement for the first time since 2004, all they really talked about was their concern about the volatility of the exchange rates. No price levels were mentioned for the Euro or the Dollar. There was not even the slightest hint that they were considering an intervention. Nervous longs did liquidate as the market neared 1.60, but that just gave the aggressive bulls a better price to add to their long positions on the small dip.
On Tuesday, the Dollar firmed for two reasons. The Euro Zone's ZEW survey showed weakness in German economic sentiment and the U.S. Producer Price Index increased more than forecast in March. The higher than expected PPI then caused financial traders to rethink the Fed's position on cutting rates more than 25 bp on April 30. Some traders went out on a limb and even suggested that the Fed was finished cutting for the year.
Trichet and the ECB were vindicated on Wednesday when a report showed that European inflation had accelerated last month. Since June 2007, the ECB has kept interest rates at 4% citing the need to fight inflation and drive it down to an acceptable level of 2.5%. The Euro surged to a new high on the news but failed to penetrate the 1.60 barrier. The high inflation number sent a signal to the market that the ECB was not likely to lower rates the rest of the year.
With this news, a bullish scenario began to unfold. The Euro bulls were looking for steady interest rates from the ECB in its battle against inflation and another round or two of interest rate cuts by the Fed to stem off a recession. This would have been the perfect bullish scenario as the interest rate differential would have widened further. The aggressive longs knowing that a widening interest rate differential was a legitimate reason to buy Euros would have bought with both hands because the G-7 would not have been able to justify an intervention.
But the bulls never got a chance to play that hand as Luxembourg Finance Minister Jean-Claude Juncker stepped up, and stated that the Euro's recent advance against the Dollar is not desirable. He went on to explain that the financial markets misunderstood the Group of Seven's position on currency volatility. While the G-7 may be concerned with exchange rate volatility, traders have not been frightened at all because the Euro has been trading in a solid trend with the fundamentals to back it.
There may be more to Juncker's comments, however. The timing of the comments must be noted as they came out just about the time the Euro was poised to breakout above 1.60. In addition, it marked the first time that an official statement had implied that the price levels of the Euro and the Dollar were the main concerns and not the volatility. His statement regarding the Euros undesirable advance against the Dollar has to be considered a direct comment on a price level. This is key because it gives a trader something to lean on. With the comments coming so close to a 1.60 EURUSD trade, this level should no longer be treated as just a psychological level, but also a possible intervention level.
There is no question that momentum and buying activity slowed down in the Euro for the rest of the week. In fact, it came very close to posting a weekly reversal down which could have attracted follow through selling next week. While Juncker's statement at this time only amounts to a verbal intervention, it nonetheless is a matter of record and will be playing on the minds of the weaker longs next week. Until the strong bulls give up their longs and change the trend to down, it is hard to say whether Juncker's statement had a topping effect on the market.
Another key indicator to watch is the U.S. Treasury market. Remember that traders base many of their decisions on the interest rate differential. The sell-off in Treasuries last week is an indication that the financial markets expect interest rates to rise. If long Euro traders built a premium in the market because they thought the Fed was going to continue cutting throughout the year, then something has to give. Another round of selling in the Treasuries along with inflationary news may be enough to trigger a sharp sell-off in the EURUSD. This is the scenario for which the aggressive bears have been waiting.
Juncker's statement may have made longs nervous, but a steep sell off in the treasuries will force long traders to take action.
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