USD Prolonged Selling Due to Risk-Averse Sentiment

Last Friday marked the most extensive trading range in EUR/USD since the US CPI data release on February 13th. Initially, the euro gained traction amidst a robust risk appetite in the global equity markets, driven by strong Nvidia earnings that boosted overall market sentiment. The momentum, however, quickly reversed as France's PMI data led to a bounce in EUR/USD to intra-day highs, followed by a swift downturn prompted by weaker data from Germany.

Notably, the France PMI data may signal potential future risks. The Eurozone has faced a persistent period of adverse economic data, especially from Germany, grappling with declining competitiveness linked to China and an energy price shock after the Russia-Ukraine invasion. The unexpected strength in the France PMI data, deviating from the anticipated trend, triggered a significant market reaction. Speculatively, had the German data been positive, EUR/USD might have retained much of its earlier gains. Unfortunately, optimism faded rapidly as the data reverted to its typical pattern. Despite challenges in German manufacturing, there are bright spots, with the services sector surpassing expectations, hinting at potential GDP growth in Q1, in contrast to the flat growth observed in Q4. This, from my perspective, could contribute to a more Euro-supportive economic landscape in the future, particularly if there is a reversal of the adverse energy price shock in Europe.

The simultaneous depreciation of the dollar amid a robust equity market performance faced inherent risks, particularly with the upward movement in US yields. Traditionally, a weaker dollar aligns with increased risk appetite, yet the data reveals a weakened correlation. Comparatively, the correlation between the dollar and 2yr yields is twice as strong as that with risk percentage changes. The 2yr UST yield, rising 50bps this month, slightly outpacing Germany's movement, coupled with the AI-related tech-driven equity market rally, raises doubts about the dollar's ability to weaken with growing risk appetite.

Despite the limited impact of the European Central Bank's (ECB) minutes on market pricing, certain details stand out. The content aligns with expectations and echoes the Federal Reserve's stance from Wednesday's meeting. President Lagarde's resistance to rate cuts, evident in both the press conference and the minutes, is noteworthy. Of particular interest is the mention of a potential cut to the inflation forecast for 2024. With the latest projections indicating 2.7% CPI in 2024, 2.1% in 2025, and 1.9% in 2026, a cut to the 2024 level, averaging the 2025-2026 levels at 2.0%, raises the possibility of an ECB cut at the April meeting. While the market still prices in a small risk (8bps), sustaining EUR rallies might prove challenging under these circumstances.