Financial market research and analysis

The euro is under pressure as France dismissed budget goals to counter-attack Syria.

The expansion in French budget for war in Syria, combined to prospects of a further unorthodox move from the ECB, could only cheapen the euro and with a bit of luck, support the inflation expectations in the Eurozone. Presently, the euro 5-year/5-year inflation swap rate, used by the ECB as a proxy for inflation expectations, stands at 1.75%. The ECB’s mandated inflation target is 2%. Mario Draghi will almost certainly not be stepping back from expanding the present QE program or going negative on deposit rates before reaching his goal. The core inflation improved to 1.10%y/y in December, hinting that the current policy is bearing fruit. The improvement did not revive any suspicion regarding the possibility of further monetary expansion by December. It seems that the recent ECB communication has been a success in terms of credibility.

The euro slipped below 1.0650 against the US dollar and is decidedly on its way to 70 cents against the pound.

Before the FOMC minutes due on Wednesday, traders continue chasing top selling opportunities to strengthen their euro short positions. In December, an additional expansion from the ECB could well be accompanied by a potential rate hike by the Fed. Such combination could resume a mid-term slide in the euro down to parity against the dollar.

Digging into the guts of the TIPS market, we notice that the US monetary conditions have been continuously tightening since April. The market gives 66% chances for a December Fed rate hike. The FOMC minutes on Wednesday could further support the Fed hawks. The Fed divergence will likely be supportive of the US dollar to the end of the year. The US inflation data is due later in the day. The headline inflation may have improved to 0.2% in the month of October, the core inflation is seen stable at 1.9% on year.

The speculative future long positions in US dollar rose to the highest since mid-August; as the yen, the euro, the pound, the Aussie and the Kiwi were sold last week.

The Loonie has been the exception as some shorts were covered. The USDCAD is again set to advance to fresh eleven-year highs on the back of a strong USD and cheap oil. Further cheapening to 1.35 per US dollar is a matter of time.

Crude is better bid however given that French retaliation against Syria could damage the supply side but could hardly reverse the oversupply conditions in the global oil market. The crude inventories in the US are back on their way to all-time-highs. The oil market could easily be handed back to the bears and the WTI futures may be susceptible to a move below $40 per barrel.