FX markets are slowly waking up at the start of this trading week. With limited news flow no one is rushing to get out of bed (end of the week brings, BoE MPC, FOMC, US jobs reports, and local UK elections). Paradoxically, US equity markets surging, volatility widely contracting yet JPY outperforming G10 peers. Confusing price action indicates that traders are having a hard time pinpointing cyclical drivers. EURUSD staged a minor bounce to 1.1175 prompting some to issue calls for buying EURUSD. Their analysis includes the forecasted stronger Q1 Eurozone GDP read and cheap relative valuations in European companies. Yet we are not convinced. Judging from last week’s weak PMI and IFO reads economic improvement has not crossed the Atlantic. Marginally shifting growth expectations in Europe will not offset very alive US equity rally and attractive real yields. Finally, ultra strong US GDP read last week (1Q 3.2% q/q) has investors rethinking the Fed pause while the ECB is nowhere near reviewing policy normalization. This divergence should benefit USD near term. We remain cautious on calls that EURUSD has built a stable base (likely short-term consolidation phase) and could easily see the establishment of a lower range.
Also limiting Euro upside potential is political uncertainty in Spain. Spain’s incumbent Prime Minister and leader of left-leaning Spanish Socialist Workers Party (PSOE) Pedro Sanchez has declared victory but with no clear majority in parliament. The market should anticipate weeks of tense coalition negotiation in a highly divisive fragmented political landscape. The most likely outcome is PM Sanchez will need to rely on Catalan separatists to form a government. This action will have a “cost” that will likely be seen as Euro negative.
