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Behind the EUR/USD Decline, Disappointments in US Data

Last updated 1/31/2012 10:26 AM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

January was a great month to be long euros but the sell-off that we have seen since the start of the North American trading session has many investors wondering whether 1.3235 will be the near term top for the EUR/USD. Weaker than expected U.S. economic data resurrected concerns about the outlook for the U.S. economy and forced U.S. equities to give up part of their early gains.  Manufacturing activity growth in the Chicago region slowed in the month of January, bucking the trend of improvements reported in the NY and Philadelphia regions.  The PMI index slipped to 60.2 from 62.2 due in large part to a decline in labor market conditions. The employment component of the Chicago PMI report fell to its lowest level since August.  Although it is encouraging to see manufacturing activity expanding in Chicago, the slower pace of growth dashes hope that the manufacturing sector will lead the U.S. recovery.  Consumer confidence is also shaky with the Conference Board's consumer confidence index falling to 61.1 from 64.8 in January.  The problem in the U.S. is that we are seeing a tremendous amount of conflicting reports.  The University of Michigan for example reported the highest level of consumer confidence in nearly a year but today's report from the Conference Board shows Americans growing less optimistic.  While economic data provides little clarity on the outlook for the U.S. economy, there is no ambiguity when it comes to the Federal Reserve's plans for monetary policy.  They intend to keep rates on hold for the next 3 years and are looking for reasons to add more stimulus.  Today's economic reports may not be enough for the Fed to pull the trigger on QE3 but they certainly validate their decision to adopt a more dovish stance in January.  The Fed does not want investors to be misled by any improvements in economic data because they believe it will be temporary especially given the amount of significant downside risks.  The persistent decline in USD/JPY suggests that investors have very little appetite for U.S. dollars even though the greenback has risen against the euro. 

Having traded as high as 1.3214 during the early European trading session, the euro has now turned lower against the U.S. dollar.  The prospect of a Greek PSI deal being reached by the end of the week fell on deaf ears along with a report by the FT Deutschland suggesting that the U.S., Eurozone and IMF could be working on a multipart rescue umbrella for the region.  Instead, investors chose to focus on rumors of a $1 trillion balance sheet expansion by the ECB.  Stepping up the size of their next LTRO is good news for the bond markets because the LTRO has successfully capped bond yields and encouraged European banks to buy sovereign debt.  There is no question that without the LTRO operations, bond yields in Europe, particularly those of troubled nations would be much higher.  However for the EUR, the LTRO is both good and bad news because it is effectively a lite version of QE.  Unless the Fed pulls the trigger on QE3, a $1 trillion balance sheet expansion by the ECB is bearish for the EUR/USD.  However, the LTRO operations have provided support for the equity and bond markets in Europe by alleviating concerns about investor demand.  If bond yields hold steady and auctions go successfully, credit conditions will ease, providing support for the EUR.  

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Comments (1)

Darkdoji

January 31, 2012 at 05:35 PM ET

Problem is the EURO went down by far more than even pairs known to be particularly sensitive to stock market fluctuations and way beyond correlated indexes. There has to be a better explanation than just the data - we are talking something in the region of a 170 pip drop. Simply does not add up.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.