Euro Bears Emerge After HICP Data; Eye $1.0710-15 - Analysts

Traders, already leaning bearishly towards the euro given recent European Central Bank commentary, became even more bearish Monday as deemed dovish flash EMU inflation data dragged eurozone yields lower.

If 10-year German Bund yields eventually turn negative, as some expect, such a move will likely drag the euro back to the 2016 lows near $1.0710-15, seen in early January, they said.

Flash EMU HICP data for February came in with a 0.2% decline year-on-year versus MNI's median expectation of a flat result. This comes after increases of 0.3% in January, 0.2% in Decembe, and 0.1% in both November and October.

More importantly, the core HICP reading slowed to an only 0.7% increase, year-on-year, below MNI's median of a 1.0% rise, with the move lower in the core a potential game changer for the ECB. See MNI Main Wire at 8:54 a.m. ET.

"From the ECB's perspective, the downward slide this month is unlikely to be a major source of surprise, given that officials have already adopted a far more conservative judgment on the inflationary outlook," said Timo del Carpio, European Economist at RBC Capital Markets.

"Still, the pronounced decline in the 'core' measure this month will likely undermine the case of those on the Governing Council who are still holding out for more information," he said.

In light of today's HICP data, taking a "'wait-and-see' approach" at the March 10 meeting "simply does not appear to be a viable policy option at this stage," del Carpio said.

In mid February, ECB Vice President Vitor Constancio said that if the "conclusions of the Governing Council" are that "the path is at stake" and that there will be a delay in normalizing inflation, then the central bank "may well decide to act," .

At the time, Constancio saw scope for headline inflation to even be negative in the first half of 2016, but stressed that this would not effect core inflation.

Inflation should begin to rise in the second half of the year, he said.

On the first negative HICP reading since last September, "February's decline was partly down to an expected fall in energy inflation on the advent of a sharp rise in oil prices in February 2015 while food inflation also weakened," said Jennifer McKeown, senior European economist at Capital Economics.

Of great concern also was that "the core rate (excluding food and energy) fell from 1.0% to a 10-month low of 0.7%, reflecting declines in both service sector and non-energy industrial goods inflation," she said.

If oil prices and the euro remain around current levels, "this latest bout of deflation could last for a few months," McKeown said.

However, Capital Economic looked for a rise in oil prices and a further slight decline in the euro to force headline inflation towards 1% over the course of 2016, bringing the annual average to roughly 0.5%.

At the Governing Council meeting March 10, Capital Economics expected the ECB to announce a 20 basis point deposit rate cut and an increase in monthly asset purchases to "E80 billion or so" from E60 billion," she said.

TD Securities Renuka Fernandez looked for the ECB to announce a 20 basis point cut in the deposit rate, a E10-E15 billion increase in monthly purchases "for at least" and extension of six months, and for "another three-year LTRO/decrease in the spread on the TLTROs."

"As such, we would expect periphery spreads to tighten, the 10-year Bund yield to fall further and for the 2s10s Bund curve to flatten further," she said.

Fixed income hedging on the part of life-insurance companies, "who account for nearly 45% of eurozone government debt and who typically run large asset liability mismatches," should weigh on 10-year Bund yields, allowing them to join shorter maturities which are already in negative territory, Fernandez said.

Ten-year Bund yields traded last at 0.106%, on the low side of the day's 0.101% to 0.148% range. Earlier yields took out the 0.129% low seen February 11.

As a reminder, Bund yields posted a record low of 0.0485% April 17, 2015. On Feb. 8 when U.S. yields topped out at 1.868%, Bund yields peaked at 0.306%.

The prospects of Germany joining Japan in having negative yields out to ten-years has market players looking bearishly at the euro, despite the 4.5% decline seen already from the Feb. 11 peak of $1.1376 to today's trough near $1.0859.

The euro was trading at $1.0888 in afternoon action Monday, on the low side of a $1.0859 to $1.0963 range.

Last week, the pair broke below and closed below an uptrend line from the December 3 lows near $1.0524, which came in a bit under $1.0940.

The market looked for the euro to revisit the 2016 lows near $1.0711 and $1.0716, seen Jan. 5 and Jan. 6.

Barclays technical strategist Lynnden Branigan was "encouraged by Friday's sell-off."

"We are looking for a move towards initial targets near $1.0850 and then the $1.0710 lows," he said.

The market will look to sell larger rallies towards $1.1050, where the 200-day moving average, currently near $1.1047, comes in Branigan said.

Friday's CFTC data, for positions as per Feb. 23, showed that speculative accounts had a net euro short of -46,847 contracts, which compared to the net short of -48,2015 contracts seen the week prior.

This is a far cry from the net short of -182,845, seen Dec. 1, which was the largest net euro short seen since May 5, 2015, when speculators had a net euro short of -190,127 contracts.

The euro closed near $1.1020 on February 23, so net euro short positions have likely increased, although may not yet be extended, traders said.

"We may yet see $1.0500 or $1.0600 again; I don't think positions are stretched," one trader said.

The euro bottomed at $1.0524 on Dec. 3, 2015, which was the lowest level seen since April 13, when the pair bottomed near $1.0521. The 2015 euro low was $1.0458, seen March 16.

CitiFX technical analysts continued to favor a euro short position versus cable.

After entering into a euro-sterling short Friday, they added to their short Monday around 0.7841.

Citi has a downside target of "at least Gbp0.74 to Gbp0.75 and possibly Gbp0.7000" and a stop-loss at Gbp0.8015, they said.

Euro-sterling last traded at Gbp0.7820, after trading in a Gbp0.77912 to Gbp0.78977 range.