EUR Buckles as Eurozone Yields Set Records

Dealers and investors are happy to walk the 19-member single unit down, and through the medium-term target, the September 2003 lows atop €1.0762. There is no fuss, no sense of urgency, just a matter-of-fact move lower for the single unit that is now backed by a quantitative easing (QE) program. The uncertainty over Greece and the onset of large-scale European Central Bank (ECB) QE continues to weigh on the EUR. This is allowing the mighty USD to continue to rack up multiyear highs across a number of currency fronts; supported by stronger U.S. fundamental data (strong U.S. jobs and full employment) and some hawkish Federal Reserve talk.

Rate Divergence Dominates USD Move

In the overnight session, Richard Fisher, the president of the Dallas Federal Reserve Bank, said rates might have to be raised “steeply” if the liftoff is delayed and that it’s better to push yields higher “early and gradually.” The Fed meets next week (March 17-18). Expect the market to be firmly focused on the Fed’s communiqué: will “patience” remain or not? Despite Chair Janet Yellen stating that she will not be held to a rate timetable, investors are looking for any subtle hints that will indicate that June will be the beginning of the U.S. tightening cycle and not the fully priced in September meeting.

Euro Falls to 12-Year Low

Like a hot knife through butter, the EUR has managed to penetrate its long-term medium target with ease (€1.0762). It’s near impossible to stop a runaway train that has momentum on its side, and the EUR backed by the newly launched bond-buying program yesterday continues to squeeze the positive out of eurozone bond yields. Under QE, the ECB began buying government debt yesterday to drive up inflation and boost a fragile economy.

The EUR had already fallen sharply this year as investors geared up for the ECB’s QE program. A percentage of the market had been expecting to witness a EUR relief rally once the QE program officially began this week. That has yet to materialize, the EUR directional play remains all one way and that’s down for now. It’s not a EUR play, but a USD play — it continues to print multiyear highs against the yen (¥122.0) and other majors, as well as commodity and emerging market currencies amid starkly diverging outlooks for interest rates globally.

The negative or low yield scenario throughout the eurozone is not an incentive for investors to hold the EUR. German 10-year bund yields have fallen to +0.28%, equaling their all-time trough. Similar debt maturities in Italy and Spain have hit their lowest yields on record at +1.17% and +1.24%, respectively. Investors should be expecting that the renewed standoff between Greece and its creditors over the terms of any fresh bailout deal to push more investors into the safety of government bonds. This will only push yields and the EUR even lower.

EUR Yields: Too Far, Too Soon

One thing to remember is that liquidity issues have been a factor that is supporting lower European yields and reason enough to remain negative on the single currency. Current liquidity constraints are in fact separating low yields from economic fundamentals. Just look at the German bund curve. Fundamentally it does not make sense that German 30-year product are trading as low as +0.90%, or lower, but the ECB’s QE and regulatory-led demand is pushing the European yield curve down. National central banks across the eurozone are able to buy assets with maturities between two and 30 years (weighted according to outstanding amounts). Banks can buy negative yielding debt up to -0.2% (deposit rate). This will be seen as an incentive to buy other assets rather than just depositing monies with the ECB. When product trades atop of -0.2%, only then will market participants become concerned.

Now that the EUR has managed to penetrate its September 2013 target with ease, there is technically no support of note ahead of the February 2003 low of €1.0665. With the EUR showing little signs of life, investors need to be patient as these moves are a general grind and not an all-out race to the bottom. Follow the European yield curve for direction. Many expect that ECB QE will compress German rates further, and, with the front end anchored at -0.2% (deposit rate), further yield flattening will occur. The market’s next target for 10-year German bunds is +15% and then toward zero/negative. As German bunds trade richer, investors will find periphery product more appealing.

China CPI Rebounds from Five-Year Lows

The lack of economic fundamental releases does not make forex directional play any easier. In the overnight session, investors focused on China. Inflation data was the hot topic, coming in mixed with a lower-than-expected producer-price index (PPI) and higher-than-anticipated consumer-price index (CPI). Food CPI contributed to the rebound, rising to +2.4% versus +1.1% prior, while non-food CPI was up slightly at +0.9% versus +0.6%. Analysts attributed the increase to holiday factors and a large rise in vegetable and fruit prices. PPI (-4.8%) has now been negative for three consecutive years, and the decline last month appears to have grown worse. Falling oil refining, chemical fiber, and material costs exacerbated the drop.

Apparently the market is not supposed to worry about China — comments from officials at the People’s Bank of China (PBoC) were made to reassure the markets. The PBoC expects Chinese CPI to remain in positive territory in the near future, and even pointed to Japan and Europe having larger deflation risks than China. The PBoC also noted that there is no risk of a hard landing in China, as the economy is stabilizing and improving.

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