5 Factors Weighing on EUR/USD This Week

German business confidence improved marginally which should have been bullish for the euro, but unfortunately the most actively traded currency pair in the forex market has remained under pressure throughout the European and U.S. trading sessions. So if the EUR/USD is not responding to economic data then what is driving it lower?

Five factors:

1. U.S. Treasury Auction

One of the big focuses of foreign exchange traders this week is the massive Treasury auction. The U.S. government will be issuing a record $104 billion of 2 year, 5 year and 7 year Treasury notes between Tuesday and Thursday. The reason why currency traders are watching these auctions is because of its scale and also because it will shed some light on investor’s willingness to fund the U.S.’ large and growing budget deficit. The auctions will be a big hurdle for the U.S. dollar this week because if demand comes up short, the dollar could get hit but it is not that simple because at the same time, weak demand could drive up yields, which is dollar positive. Either way, over the next couple of days, there will be a lot of focus on the Treasury auctions.

2. First ever 12 month ECB refinancing

The ECB refinancing is the biggest story for the EUR/USD this week because the 12 month offer is seen by bond traders as a quasi quantitative easing effort by the ECB because the operations are most likely going to be collateralized by government bonds which can then be posted as collateral to the ECB for funding. Although ECB President Trichet warned that their monetary policy actions can be easily unwound if needed, he also said that policy makers must remain alert despite signs that the slump is decelerating because “there are still risks of a sudden emergence of unexpected financial turbulence.”

3. Fears that German Debt Could Explode

As for Germany, Deputy Finance Minister Werner Gatzer said that total new debt could exceed EUR100 billion next year, which would be much larger than this year’s record financing needs of EUR80 billion. Looking ahead, we could see further weakness in the EUR/USD if Tuesday’s PMI figures fall short of expectations. Despite the improvement in business confidence, which was driven entirely by the expectations component of the report, current conditions remain weak.

4. Comments from ECB President Trichet

Although ECB President Trichet warned that their monetary policy actions can be easily unwound if needed, he also said that policy makers must remain alert despite signs that the slump is decelerating because “there are still risks of a sudden emergence of unexpected financial turbulence.” These bearish comments came after ECB member Nowotny said this morning that interest rates could remain unchanged into 2010.

5. Tuesday’s PMI numbers

However in the near term, weaker economic data could keep the EUR/USD pressured. German industrial production, factory orders and retail sales have all declined which could prevent a meaningful pickup and possibly even deterioration in manufacturing and service sector PMI.

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6 Comments

  1. Hi Kathy,

    May i know why a rise in Treasury Yield is a Dollar Positive? Rise in yield signals a weak demand for T-bills right? Meaning to say, it will cause higher to borrow the same amount of money, and also means lesser investors want T-bills, thus demand for USD goes down which is dollar negative instead? Please kindly advise. Thanks! :)

    Best Regards,
    Nicholas

    Reply
  2. hi Kathy, as i also see these factors weighting down the EUR, traders may be more focused this week on the FOMC decision and still worried about more Quantitiative Easing measures from “Helicopter-Ben”. So there is the decent possibility that EUR/USD may even rise before the FED meeting.

    Reply
  3. Nicholas.
    if I may try to answer your question.

    in general, a higher yielding currency benefits in a carry trade sense, because low yielders will be sold (driving them down) and higher yielders will be bought (driving them up from demand), and the investor collects the difference in yields. the risk of course is devaluation of the bought currency to the sold currency. the AUD/JPY carry is a classic example. currently, the US and Japan are the lowest yielders, meaning they are funding currencies to any potential carry trade. If the US moves its rates higher, it may not become an investment currency but at least it may not be a funding currency.

    However, this time it may be different, because if the rates are bid too high (in order to get the debt sold), it will impede the economic recovery, and drive the current acct and budget deficits higher, which hurts a currency.

    The story the Fed tells tomorrow will be interesting. if they talk about exit strategies the $ may do well.

    Reply
  4. Thanks Paul for your effort! :)

    What you mentioned is that a high yield curbs the recovery as it will cause people to pay a higher rate with borrowing money, drive the current account wider and stuffs like that which is still dollar negative

    But Kathy mentioned that rise in yield is dollar positive though. I wonder if its a typo error? haha

    Best Regards,
    Nicholas

    Reply
  5. I agree these factors could be weighing on the Euro, although the Euro has been ranging lately, rather than declining. I would argue that most of the weight is caused by a shift in perceptions from the initial “green shoots” economic recovery view to a view that a global recovery may not happen that fast after all. Great post!

    Kris Matthews

    Reply

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