Overcrowded trades are becoming slaughtered most recently with the greenback pushing to one month lows against the euro and yen. After being burned by selling euros pre-ECB, traders have become hesitant to hold long dollar positions into the FOMC, but as each day passes investors are also becoming more convinced that lift-off will commence this month.
This is against the backdrop of nearly all pundits’ assessments that the medium-to-long term trend in this pair is to the downside. Many market contributors were ready for an extension of the rising momentum that had been started by the actions of the ECB last week, when it revealed much smaller than projected measures to extend Quantitative Easing (QE), but were nevertheless surprised when the pair headed through the big figure and seriously psychological barrier of 1.10.
Market misjudged ECB’s objectives
ECB hawk Ewald Nowotny declared that the market extraordinarily misjudged the ECB objectives. Mr. Nowotny said that market expectations before the policy statement were ridiculous, noting that analysts had the fundamentals all mistaken. He said that it’s not the job of the ECB to correct market expectations but rather to follow the policy it thinks is best. To say that Mr. Nowotny’s comments were insincere would be too kind at best. It is undeniably the purpose of the central bank to set market expectations in order to accomplish price levels and that the exchange rate mechanism is one of the most efficient policy tools to stimulate growth in the export-centric eurozone.
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Benefits of current QE uncertain
Mr. Nowotny’s hawkish tirade shows that there must be severe disagreement on the magnitude and capacity of the ECB QE program. The hawks on the board are no doubt reassured by the initial signs of development in the region and are consequently unwilling to add any additional stimulus. Yet their very hawkishness could frustrate Mr. Draghi’s efforts to generate a sustainable recovery in the region by counterproductively pushing the euro higher.
EUR/USD below 1.1000
There is no doubt that the ECB members would like to keep the EUR/USD under the 1.1000 level for a sustained period of time in order to both generate export growth and eradicate disinflationary influences from the system. The stronger currency will make reaching their inflation targets more demanding particularly in an environment where oil prices have fallen 10% post ECB. Yet the extent of the EUR/USD short squeeze is undisputable and Draghi may be the only one that could stop the pair from pushing higher.
So the crucial question to ask is whether the markets have priced everything in and the USD’s rally is finished. There’s no doubt that this leg of the dollar’s uptrend is approaching an end but there could still be an additional push higher pre-FOMC.