EUR/USD: Widening Fed/ECB policy divergence could expose 1.10 next

<p>Markets are generally quiet in data-less trading so far today, but that is likely to change with the changing of the season tomorrow. Tonight’s Caixin […]</p>

Markets are generally quiet in data-less trading so far today, but that is likely to change with the changing of the season tomorrow. Tonight’s Caixin Flash Manufacturing PMI report from China, the world’s second-largest economy, should inject some volatility into the markets more broadly, but for EUR/USD, central bank rhetoric will remain the primary focus.

After a surprisingly dovish outlook last week (including the decision to leave interest rates unchanged), Federal Reserve policymakers are seemingly trying to guide the markets back to a more hawkish view. Each of the three Fed speakers (William, Bullard, and Lockhart) that have spoken since last Thursday has struck a clearly optimistic tone (emphasis mine):

San Francisco Fed President Williams

  • Thursday’s decision was a “close call”
  • Full employment should be achieved “in the near future”
  • Views the “next appropriate step as gradually raising interest rates, most likely starting sometime later this year
  • China situation not “dire”
  • Overall “quite positive about the outlook for the U.S. economy”

St. Louis Fed President Bullard

  • Thursday’s decision was a “close call”
  • “There’s a chance” of an October rate hike
  • “Powerful case to be made that it’s time to raise interest rates… Policy settings are [in] an emergency [setting, but] the economy itself [and] the goals of the committee have essentially been met.”
  • Even if rates go up, monetary policy will still be accommodative
  • The Fed cannot permanently raise stock prices.
  • Fed has “a strategy. The strategy is go a little bit earlier and go gradually”

Atlanta Fed President Lockhart

  • Confident the much-used phrase ‘later this year’ is still operative.
  • “Comfortable enough” with inflation to initiate a hike
  • U.S. economy “performing solidly,” “met the criteria” for further improvement in the labor markets
  • Wage pressure has become more widespread
  • Supports a hike “in one of the coming FOMC meetings”

This persistent drumbeat of more optimistic rhetoric hints at a concerted effort by the Federal Reserve to ensure that traders are prepared for an interest rate hike later this year, perhaps as soon as next month. Looking ahead, Federal Reserve Chairwoman Janet Yellen will take the stage on Thursday and will likely echo the hawkish verbiage of her colleagues. If she does, it could further benefit the dollar.

ECB moving in the opposite direction

Across the pond, the situation could not be more different. In an interview with a Swiss newspaper over the weekend, the ECB’s chief economist Peter Praet reiterated that the central bank was willing to “modify” (read: expand) its massive QE program if needed. In surprisingly clear terms (for an economist, at least), Dr. Praet noted that “the euro area is in a very different cyclical phase from the U.S. economy. Therefore, our monetary policy cycles are also not synchronized. Nonetheless, we share the concerns about the prospects for the global economy.”The ongoing and widening monetary policy divergence between the ECB and Federal Reserve is a theme that may continue to drive EUR/USD lower over the coming days and weeks.

EUR/USD: Technical view

Speaking of the world’s most widely-traded currency pair, EUR/USD recently broke below a key 6-week bullish trend line, as well as its 200-day MA, around 1.1200. With the daily MACD indicator rolling over to drop below its signal line, it appears that the near-term momentum may be turning in favor of the bears.

Looking ahead, the next target for sellers may be the 50-day MA around the 1.1100 handle; this level also coincides with previous support from the early-September lows. If sellers are able to overcome that near-term support level, a deeper drop toward the 6-month bullish trend line around 1.10 could be next. Only a confirmed recovery back above the 200-day MA near 1.1200 would shift the short-term bias back to neutral.

EURDAILY9-22-2015 8-56-27 AMSource: City Index

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