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EURUSD has risen more than 1.5% since Friday and today broke above 1.3100. A double whammy has helped boost the EUR in recent days: weak US Non-Farm Payrolls and also the BOJ uber-stimulus. Traders have ditched the dollar (as expectations have grown that the Fed will stick to its QE path if employment data remains weak) while the yen's demise was solidified after the BOJ announced JPY 7.5 trillion of government bond purchases per month in its valiant effort to end deflation. The result: EURUSD jumps 300 pips and EURJPY is up a whopping 1000 pips since the start of April.
Don't fight the BOJ?
But can it last? While the Fed and the BOJ are both powerful market forces that we don't like to stand in front of, we are sceptical that euro strength can continue to gather pace for a few reasons: 1, EURJPY strength could undermine the competitiveness of German exports, especially versus Japan, who has a similar export mix to the Eurozone powerhouse. Germany is the most powerful economy in the currency bloc and needs to remain strong to support the bailout fund and to limit the decline in Eurozone GDP. This leads me onto point 2, It's not only Germany that needs a weak euro, so to do the peripheral economies as they reign in public spending and try to rely on export sales to support their weakened economies. Thus, EURUSD and EURJPY strength are both a hindrance to Eurozone growth and competiveness, two things that the currency bloc desperately needs to improve. This leads us to point 3, how much euro appreciation will the ECB tolerate? ECB President Mario Draghi was able to talk down EURUSD by 10 big figures after his February press conference without one change to ECB policy. He has room to cut rates and the inflation outlook is so weak in Europe that we could see ECB stimulus in the coming months if it deteriorates any further, thus putting the break on EUR strength. In the past Germany has been anti ECB stimulus over fears that it could cause asset bubbles and inflation down the road, however, if excessive euro strength threatens its economy it may be more supportive of ECB action.
ECB could put break on EUR strength
So what does this mean for the trader? In the short term, momentum is on the side of further EUR gains, but the closer EURUSD gets to some key technical levels we could see some profit taking in advance of potential ECB action to stem EUR strength. The first level to watch is 1.3122 then 1.3150 - the 50 and 100-day simple moving averages respectively. The other big level to watch is 1.3240 - the base of the daily Ichimoku cloud, above this level is the end of a technical downtrend. We think this level, in particular, could spur some profit taking, especially as the fundamentals in the currency bloc remain weak.
Industrial data out of Spain and Italy today showed large declines. In Italy IP fell 0.8% in Feb and is down 3.8% in the past year. In Spain the situation is more dire, IP is 6.5% lower compared with this time 12 months ago. France may have seen some increase in monthly production data, but output is still down on a year ago. It now looks like the fabled second half 2013 economic rebound may not happen. The EU's Ollie Rehn had harsh words for some Eurozone members today: he said that France needs a further policy response to boost the economy; it needs to boost competiveness and exports to get out of the hole that it currently finds itself. Likewise, Rhen said that Slovenian banks "probably need recapitalisation" as most banks in the country remain over-indebted. Hence, Slovenian's with more than EUR 100k in their accounts may be looking to find ways to move their cash in the coming weeks. Added to this, Italy's government estimates that public debt will surge to 130.4% of GDP this year. Interestingly, more than 3% of this is down to Italy's contribution to the Eurozone's bailout fund...
So the euro could be due a correction, sooner or later. What about USDJPY? It continues to climb higher, and even the traditional yield relationship between USDJPY and US-Japanese yields has been distorted. We will discuss the distorting effects of the BOJ action in a later post.
Later today Fed minutes will be in focus. These seem fairly out of date now since the meeting was prior to Friday's payrolls. But signs that QE3 was still on the menu for Bernanke and co. before the disastrous March payrolls could weigh on the USD later today.
One to Watch: USDZAR
One area that has seen the benefit of loose monetary conditions in the US and Japan has been emerging market FX. We like the rand as it has had less of a move compared to other currencies like the Thai Baht and the MXN. In recent weeks the rand has started to move as investors (including those moving out of Japanese debt) are attracted to South Africa, where 10-year yields are the third highest in emerging Europe and Africa. Foreign investors have been stocking up on South African debt, which has fed inflows into the ZAR. This may support domestic fundamentals; the stronger rand could help thwart inflation and reduce the need for further rate hikes, which could boost consumer confidence and consumption, helping to prop up this risk-fuelled rally in ZAR. We believe that a drop below 8.8825 - the 100-day moving average and a key support zone - could see further USDZAR selling back to the 8.77 February lows, initially. 8.69 is also worth noting as it is the 200-day exponential moving average, below this key level is a very bearish development for this cross. The daily MACD is not yet at overstretched levels, suggesting that momentum is still to the downside.
Kathleen Brooks| Research Director UK EMEA | FOREX.com
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