FOREX: Another welcome boost to the EU economic sentiment

Before traders see the slight improvement to recent data from Europe as an indication that the EU economy is recovering, caution is required particularly in light of recent talk of further stimulus from the European Central Bank (ECB). While it is a positive sign that the German ZEW Survey was stronger than we have seen it recently, it is still some way off the performance levels for which we know Germany is capable. Additionally, quarterly EU GDP growth at 0.2% still poses the question of whether Europe’s economy is stagnating.

ECB President Mario Draghi attracted headlines as recently as Monday for saying that any expansion of the ECB’s Asset Purchase Programme could include government bonds, however Draghi making good on this statement is a different matter. The markets continue to focus on the question of whether the ECB will introduce QE as if it is the answer to all of the EU’s economic problems. It should be noted that Japan is one of the heaviest users of QE and the Japanese economy entered another recession on Monday morning.

Is QE a successful tool to normalise monetary policy or only a pathway to achieving a weaker currency? I believe it is the latter. I also believe that Mario Draghi is mentioning QE because he wants to tempt investors to price in further ECB stimulus, which will send the Eurodollar lower. As soon as the Eurodollar dropped from its May high of 1.3990, there was optimism that the weaker Euro exchange rate would improve economic data. I am hopeful that this is what we are starting to notice, especially given that within the past month, EU PMIs returned to growth, inflation edged slightly higher and the EU GDP figure improved. EU PMIs on Thursday could provide further insight into this trend.

Investors will be focusing on the FOMC Minutes release today and whether talks about raising interest rates are elevating within the Federal Reserve. There remains some optimism that the Fed will continue normalising monetary policy and begin raising interest rates early in 2015, but I have my doubts over this. I believe the FOMC Minutes release poses a downside risk to the Dollar and this would occur if the release shows further concerns from policy makers over the global economy. If this concern is reflected in the minutes, it would likely delay the US Federal Reserve from raising interest rates, which could in turn inspire investors to close USD positions. The Fed might also mention again that the higher valued USD poses a risk to Inflation, with the latest reading announced this Thursday. Alternatively, it could point to the stronger Dollar hurting US exports, with the recent Trade Deficit release unexpectedly widening.

Overall, it really wouldn’t surprise me if the FOMC Minutes release showed greater anxiety over the global economic recovery, especially given the recent focus of the G-20 summit was on the global economic recovery and UK Prime Minister David Cameron stated only days ago “we’re on the brink of another global recession”. Already this week, Japan, the world’s third largest economy, has entered a recession and there have been further indications that, China, the world’s second largest economy is slowing down. Even the UK, the world’s fastest growing economy according to the IMF, is on the brink of entering a completely unexpected period of low inflation levels. All of this provides valid reasons for the Federal Reserve to show some caution and wait to see if the global economy makes progress in the coming months before making a decision on when to begin raising rates.

If the Federal Reserve does inspire investors to close USD positions later on Wednesday evening the EURUSD pair would likely benefit from risk appetite. The Eurodollar has opened Wednesday’s trading at around 1.25 and it has recently found stubborn resistance around 1.2570, which is blocking the pair from entering 1.26. If the Fed does inspire widespread USD profit-taking, we should see a challenge to this level once again.