The Eurozone Purchasing Manager Indices (PMI) came out below expectations adding growth fears to existing concerns about defaltion
The PMI indices measure activity in key sectors such as manufacturing, services and retail, and the preliminary results for May showed manufacturing decline to 51.5 from 51.7 when it had been expected to rise to 51.9; services, meanwhile, came out unchanged at 53.1 when it had been forecast to rise to 53.3.
The Composite Eurozone PMI, which combines results for all the sectors, hit a 16-month low, although it remained in expansion mode.
German and French manufacturing were both strong, showing either a higher than expected result or, as in the case of French Manufacturing no-change from the previous month.
Information Provider Markit's Chief Economist Chris Williamson, said, commenting on the data that:
"The survey therefore paints a picture of a region stuck in a low-growth phase, managing to eke out frustratingly modest output and employment gains despite various ECB stimulus ‘bazookas’, a competitive exchange rate and households benefitting from falling prices.”
The euro fell from a level of 1.1230 before the release to 1.1205 afterwards.
Technical Studies Favour More Downside on Balance
Our studies suggest the EUR/USD will probably continue its decline in the week ahead after falling briefly to 1.1180 on Thursday May 19.
The key 1.1210 support level now appears to have been decisively broken, opening the way to further downside.
A break below 1.1175 would provide confirmation of a move down to the next support level at 1.1125, just above the S2 monthly pivot, a support level traders use as a guide for where they see prices rotating.
1.1145 could also be a level to watch, according to analysts at OUB Bank, and Commerzbank’s Karen Jones:
“As highlighted yesterday, extension lower to 1.1140/45 would not be surprising but a clear and sharp drop below this level is not expected (momentum indicators are lackluster at best),” remark UOB’s Quek Ser Leang and Lee Sue Ann.
Nevertheless, whilst acknowledging support at 1.1145 level, Commerzbank strategists are more bearish and sees the next target at the 1.1037 channel low.
Rate Differentials Argue for More Range-Bound Trade
Typically it is the difference between interest rate yields in the United States and Europe that tend to dictate direction in the EUR/USD.
In short, investors shift money in either direction to take advantage of the better return of investment. This 'difference' can be referred to as the yield differential - where it goes often the exchange rate follows.
Analyst Kit Juckes at Societe Generale has pointed out that the EUR/USD has been particularly prone to following the differential in the ten year bond:
Juckes' assessment is, "the EUR/USD chart still tells a story of range-trading," while the spot rate is high in the range relative to real yields.
"But it would take an inconceivably big move in US yields to drive us back to last
year’s lows any time soon," says Juckes, suggesting the prospect of a major and sustained break lower in EUR/USD is unlikely near-term.
Dollar Strength Returns, Not Yet Confirmed
The dollar’s May recovery continues, with price on the dollar index moving back above the 50-day moving average for the first time since early March, confirming the uptrend remains valid.
When viewed at weekly chart level, the lows from 2015 represent major support.
“The brief dip below that support level and subsequent reversal to regain that support level, followed by further advance since suggests that the low printed on the 3rd May could well have been a key reversal low and that the dollar may continue higher from here over the coming weeks. For now, the long-term trend is still down for the dollar,” says Phil Seaton at LS Trader.
US Federal Reserve Members Driving Dollar Recovery
The recovery seen on the charts has developments over at the US Federal Reserve to thank - the Fed is telling markets interest rate rises are coming, thereby fuelling dollar buying.
Investors will continue to buy dollars in order to expose themselves to higher yielding US investments over coming years.
The minutes of April’s FOMC meeting had a hawkish tone, with most members judging that, if incoming data continue to perform well, it will “likely” be appropriate to raise the funds rate at the June meeting.
The Fed seems comfortable with the state of the economy: willing to look through the soft readings on Q1 activity and to put more weight on continued labor market improvement.
Yet the Fed remains split over the role external developments should play in the setting of monetary policy, with some members taking the view that the US economy is likely to remain resilient to external shocks while others “noted that global financial markets could be sensitive to the upcoming British referendum on membership in the European Union or to unanticipated developments associated with China’s management of its exchange rate.”
“To us, the important question is whether the April minutes aimed to send a signal about intended action at the June meeting or whether the Fed simply wants optionality. Our view is consistent with the former,” says Michael Gapen at Barclays.
To be sure, if markets price out a June hike, Fed action at the meeting could introduce unneeded volatility; hence, talking up possible action in June, but not committing to action, keeps the Fed’s options open.
Of course this creates problems for the US dollar in that any backtracking in intent could seriously undermine the recent rally.
“That said, in the details of the minutes and in the repeated references to June in the minutes and in recent speeches, we detect something closer to intent,” says Gapen.
The path to a June hike, in Barclays’ view, remains possible but the road is narrow; the data have to cooperate, financial conditions need to remain supportive, and the committee needs confidence to act in advance of the UK referendum on EU membership.
Analysts at the bank retain a view that a rate hike in July or September (their baseline) is more likely and look to Chair Yellen’s speech on June 6 for further guidance.
What Matters for the Euro and Dollar in the Week Ahead
An important factor in the week ahead for the pair, will be how traders perceive the US central bank operating.
Ever since the release of the Federal Reserve (Fed) meeting minutes made it clear the Fed were serious about raising interest rates in June, the focus has turned to data, in an attempt to ascertain whether it is good enough to warrant such an early hike.
The coming week’s data, especially Friday’s Q1 GDP second estimate, will be being viewed therefore within the context of how it impacts on the June Federal Reserve policy meeting.
Analysts currently see a surprise to the upside of 0.8% for GDP from the preliminary 0.5% result. Such a rise would almost certainly lead to an appreciation of the dollar as it would help fuel expectations of an interest rate hike in June.
Durable Goods Orders is another release which could support expectations, whilst housing data may also have an influence if it surprises.
The euro, meanwhile, remains subdued as analysts wait for inflation to pick up. It has come out at -0.2% for two months running now which is starting to place slight pressure on the European Central Bank (ECB) to act.
At the April policy meeting press conference Mario Draghi warned that interest rates might “turn negative” in the next few months, however, so the current drop is not completely unexpected.
Draghi added he expected inflation to recover in the second half of the year as higher oil prices and the ECB’s policies began to ‘pass through’.
It is not until the summer that we will be able to gauge how accurate this forecast is and whether inflation can recover, or whether the ECB will need to take more action (negative for the euro).