Time for a Euro Squeeze After Draghi and Ugly US Data?

Ugly US data sees earlier risk rally turning tail rather than rallying on QE3 anticipation. Will the Euro see a squeeze in the crosses after ECB fails to offer rate cut hint and after strong Spanish and Italian debt auctions?\

Draghi puts us to sleep
For all of the drama in the Euro Zone of late, the ECB meeting today had little to offer – which made some sense given the fairly dramatic measures taken the last time around and the apparent success of the ECB of late in keeping sovereign yields across the Euro Zone lower. But the lack of helpful guidance perhaps made less sense given some of the alarming signs of a slowdown of late in the core EU countries and given the general fear level.

On the economy, Mr. Draghi outlined the risks and the uncertainties (inflation not among them), but insisted that there were “tentative signs” of stabilization at a low level. He also complimented what he saw as strong action taken on fiscal measures and hopes that the new fiscal compact (new EU treaty/sub-treaty) would be helpful and would be agreed upon at the Jan 30 EU summit rather than having to wait until March. In any case, Mr. Draghi refused to hint anything at all about the possibility of a rate cut, which has certainly helped the Euro to recover fairly smartly later in the press conference.

Italian and Spanish debt auctions
The biggest boost for the Euro intra-day was found on the back of a very successful Italian and Spanish debt auctions (12-month and 6-month bills for Italy and 3-year and 4-year bonds for Spain), which saw huge demand nearly twice the targets for the auctions.  These auctions underline the hope that the poor auctions just ahead of the New Year might have been a result of thin liquidity and seasonality rather than a problem with demand. With today’s results, Italy’s and Spain’s 2-year borrowing rates are now less than half of what they were at the worst levels of last November, at below 4.00% and below 3.00% respectively.

Chart: EUR/USD
EURUSD has made a local double bottom and the question is whether it is time for a bit of consolidation after the ECB failed to hint at a rate cut and after the impressive slide in Italian and Spanish bond yields on the day. If we see the Euro consolidating in an environment of general risk aversion, the more volatile crosses may be the likes of EURAUD and EURNZD, etc. Upside resistance in EURUSD comes in at 1.2820 and then at 1.2920 and 1.3000. To the downside, the double bottom at 1.2665 is the focus.
EUR/USD" title="Chart: EUR/USD" width="445" height="343">
Ugly US Data
After the long string of very good to slightly good to somewhat neutral data, finally we get some very ugly data today which may hint that the long run of upside surprises in the US data is drawing to a close. Weekly jobless claims came in at a 6-week high, and the inevitable upward revision next week could make that an 11-week high (if revised above 404k). As well, after all of the talk of a strong Christmas shopping season, the Retail Sales report suggested that sales ex Autos and Gas were flat relative to the +0.4% expected. The story was supposed to be that we had heavy volumes even with the heavy discounting to attract customers –it appears that the good deals were unable to force customers to spend more. The reaction in the wake of the data is inconsistent. The “QE3 is nearer” trade would be to sell the USD in anticipation of more liquidity and possibly to drive risk assets up. Instead, we’re seeing risk off after the data and the USD weaker against the Euro, but holding against the Aussie. If the risk off move continues, certainly this will keep the USD well out of the “weakest” category (independent of whether Euro squeezes higher - see below) among the major currencies.

Looking ahead
Today’s US data may indeed prove to be a turning point, as we mentioned above and have mentioned in previous posts – as the positive/negative surprise cycle is quite regular and was clearly peaking recently. From here, then, we may therefore get our test on whether a negative risk cycle will actually help to support not only the USD, but perhaps the Euro as much or even better for the shortest term, in the event we see a positioning squeeze (since, in the recent cycle of complacency, the Euro became the preferred short rather than the USD, meaning if risk rolls over, the short squeeze pressure could be higher in the shortest term in the Euro crosses from a positioning perspective, provided nothing ugly turns up in the Euro Zone news flow.)