What happens when you’re not looking

As I write the Euro is heading towards the high printed at the end of last year, 1.3893. This just after Bloomberg’s Chart of the Day on Monday was entitled “Euro suffocated as 2014 Range is the least on record” – in other words, the Euro has never started the year in a tighter trading range versus the dollar than it has now (see attached). Ironically the previous low was 2007 and we all know how that year ended up (the words “Northern” and “Rock” spring to mind). Implied EUR/USD volatility is also back at the lows of 2007.

Frustration and disinterest abound. Today’s non-farm payrolls is the least eagerly anticipated for months, as the market has had to contend with the impact of weather on data which is apparently the key input for the Fed’s reaction function. What normally happens in markets when people aren’t looking? That’s when trends begin…

So what could we see from here? Mr Draghi yesterday sounded relatively upbeat, and why shouldn’t he. Money market rates have fallen back to their lows, peripheral yields continue to tighten (Spanish 10years now half the levels of 2 years ago), and his favourite economic measure – the PMIs – are picking up. “But what about all the deflation?” cry the doom merchants. Well that was a natural consequence of restructuring economies within a fixed exchange rate regime. If it became entrenched, Draghi would argue that they have a long toolkit of measures they can use. Indeed the open debate within the ECB over the last few months is a sign that he’s getting his ducks in a row should the need arise. Government by consensus requires that debate.
So the ECB are letting their balance sheet shrink just as others are increasing theirs. 1.4000 on EUR/USD would be a pain trade for underhedged European corporates. Alongside this, risk sentiment continues to show resilience. Despite everything thrown at it, from a Fed who reiterate their commitment to taper despite the weather, to Ukraine/Russia/WW3 worries, the stock market carries on going up regardless. The Nikkei is now down only 6% YTD, having previously been the worse performing stock market of the year. It’s all good news until it isn’t, so watch out for buyers of EUR/JPY in the near term as “Goldilocks” plays out for the financial markets – not too hot, not too cold, and don’t make me think about the 3 bears.

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