As the world is one big interconnected financial system, traders must keep an eye on many markets. It is a very good idea to track how much money is flowing between countries. A currency leaves a country where there are troubles due to bad management or war for a more reliable jurisdiction. In the coming days, we will all be waiting for news that will clarify whether the Federal Reserve or ECB will tighten sooner than they have currently expressed or possibly not tighten as fast as we expect.
Forex Analysis – EURUSD
As investors focus on tomorrow's US inflation data and next week's Fed policy meetings, Eurozone government bond yields are beginning to fall.
The new Omicron variant was shown to be neutralized with a 3rd shot (Booster) in a laboratory test by BioNTech and Pfizer's COVID-19 vaccine and this will hopefully take some of the stings out of the disease and return the markets to a risk-on sentiment when the evidence is concrete.
Germany's 10-year government bond yield fell 2.5 basis points to -0.335% after setting the biggest daily rise in two weeks on Wednesday, up more than 6 basis points, and yesterday's US 10-year bond auction resulted in a drop in the benchmark yield though they remain relatively high for the year. The benchmark yield curves for Germany and the USA give a clear directional bias to the currency pair as money managers hunt for some return in a world of zero and negative interest rate policies.
ECB board member Isabel Schnabel stated the ECB should not change its policy-making order even if that means raising government borrowing costs. A backstop, however, may be necessary to prevent market fragmentation. The ECB has followed the same line as the Fed and has long indicated that an interest rate hike will only come "shortly after" quantitative easing ends. Hence why the Fed is looking to accelerate the taper. Analysts and policymakers are now considering changing the order of the two steps to combat the rising inflation.
The euro had bounced on some good economic data out of Germany with regards to their industrial output. German manufacturing would also benefit from a weaker euro when it comes to exports and the overall trade balance.
The recent price action in the EURUSD is for me carving out a bear flag. My bias based on the interest rate differentials is that the EURUSD comes lower, and we go short on a breakdown of the rising channel. However, there is a double top at the 1.3800 level which could be tested first as a liquidity grab. The result would look like a possible test of the upper bound of the rising channel or a head-fake of the horizontal resistance line.
This could all change if the US CPI comes in lower as expected or maybe even worse than expected. Traders are banking on the FOMC meeting next week being explicitly focused on tightening their monetary policy faster, with the aim of cooling the economy. If however, the Fed won't come out as Hawkish as we expect this could drop rate hike expectations for 2022 and the German 10-year yields could rise against the US 10-year yields. This would probably translate to a higher EURUSD.
The weekly EURUSD chart for me shows the importance of the current levels. 1.3200 was a very strong level of resistance and is now acting as a decent support. If the Fed has got their timing and policy wrong in the eyes of the bond markets, a shift into the Notes and Bonds would drop the US yields and we could see the EURUSD going higher to test 1.6300 to 1.6500. If this is the bullish and currently unexpected direction of the EURUSD, the 1.3800 level could act as support and that is where I would look to buy for a longer-term ride up to the weekly resistance levels a couple of hundred pips away.