Draghi Lets Steam out of Euro

new eu

The combination of stronger US economy data and a dovish Draghi has seen the US dollar go bid.  The price action lends more credence to our anticipation that the dollar’s downside correction, which began, we argue shortly after the Fed hiked in the middle of last month, rather than the start of the year, is over or nearly so. 

Draghi’s general tone and assessment did not change despite the near doubling of the rate of headline inflation from 0.6%  to 1.1% in November-December period.  He suggested that the rise in price pressures is mostly energy and that he sees “no convincing upward trend in underlying inflation.  As we noted, core inflation stand stands at 0.9%.  The trough was 0.6%.  Draghi also said that risks to the economic outlook remain to the downside.   He reiterated that rates will remain at present levels (low) or lower for an extended period of time.  If he had removed the “lower.” his comments would have been seen as more hawkish.

Draghi dismissed concern that some countries have low inflation and some high.  He specifically said that the “heterogeneity” of inflation.  Remember that, within reason, the higher German inflation relative to the periphery, means that Southern Europe will gain in competitiveness with the North if it can be sustained.  This is tantamount to an internal revaluation of the euro in Germany, just like lower inflation in the periphery was sometimes seen as an internal devaluation for Greece, or Italy, or Spain, for example.

Draghi’s attitude toward the new US Administration is also instructive.  When asked about Trump, Draghi said he would rather comment on policies not statements.  This seems like the general attitude among many investors.  The tweets and such are distractions.  The importance are the policies and priorities of the Trump Administration.

The US two-year premium over German is edging higher and pushing through 195 bp, it is the widest since January 4.near 195 bp.   The peak on December 28 was almost 206 bp, the most since 2000.  A sustained break of the $1.0575 area would weaken the technical tone of the euro, though it may need to break $1.0485 to signal a retest on the $1.0340 multi-year seen at the start of the year.

Rising US yields are also lifting the greenback against the yen.  The next target is JPY115.60 and then JPY116.30.