EUR/USD Posts 3 Year Highs – But What’s Really Going On?

Market Drivers January 12, 2018

  • Euro takes out 1.2100
  • Markets wait for US data
  • -0.24% 0.11%
  • $63/bbl
  • $1330/oz.
  • $13500

Europe and Asia
CNY: 54B vs. 37B

North America
USD: 8:30
USD: 8:30

Boosted by news of progress in German coalition talks, the took out three-year highs today is early European trade hitting 1.2136 before finally settling down a bit.

The pair has been in a relentless rally since last year and has served as the prime beneficiary of anti-dollar flows as markets begin to price in the prospect of an ECB taper later this year. Tonight’s boost, however, came after SPD leader Schultz announced that her a preliminary agreement for coalition rule with Angela Merkel.

Ms. Merkel will remain the Chancellor and more importantly will have a stable majority in the Bundestag rather than ruling via a minority government – a fact which has clearly pleased the market as it pushed the pair through long-term resistance at 1.2100.

Although most analysis of the euro strength has focused on the real relative yield differentials, with the lack of any discernible inflation in the US and the absence of any dramatic pick in consumer spending, we think that the recent strength in the single currency may be political as well as economic.

Consider the contrast of Ms. Merkel’s calm and steady leadership versus the perpetual mayhem of the Trump White House. Setting aside the racist rhetoric and the anti-trade stance, the Trump economic program rests solely on the assumption that the coming tax cut will spur a massive increase in spending and generate greater than 3% growth. However, should spending fail to materialize the US will be left with a gaping budget deficit and no buyers for its debt as Fed exits from QE and upward pressure on rates coming from liquidation in the Treasury markets could trigger a vicious cycle of lower growth and higher rates.

We have been noting the massive disconnect between the rise in US yields and the decline in which today hit a low of 111.00 in morning London dealing. Such a dynamic only occurs when the markets begin to lose faith in the currency of the country. Mr. Trump’s gamble may yet pay off, but for now the market is betting the other way.

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