GBP/USD under performance Vs EUR/USD and tight ranges is attributable to correlations in relation to counterpart pairs. GBP/EUR is a vital pair in the GBP universe yet it correlates to GBP/USD 0.11%. GBP/JPY is the best correlation at 77% followed by GBP/NZD at 30%. Even GBP/CAD, the “Carney Cross” negatively correlates at minus 0.02%. GBP/AUD and GBP/CHF further follow negative correlations at minus 0.07% and minus 0.27%. GBP/SEK is positive 0.28% yet GBP/NOK and GBP/ZAR shares negative correlations at minus 0.02% and minus 28%. Of 10 pairs, 4 are positive and 6 negative. Of the positive correlations, 3 pairs are weak and far below 50& while GBP/JPY remains strong at 77%.
Why continued focus on EUR is because GBP has been literally stuck in dead ranges and has severely under performed EUR. Secondly, GBP ranges no longer can hold and I’m expecting a range explosion to the downside. What’s inside the current GBP price is pure noise.
Last week break on Draghi comments of 1.1236 and 1.1155 remains stasis at 1.1155 as 1.1236 crossed below 1.1155 and is now located at 1.1143. Also mentioned last week was the point at 1.0895 was a must break line to see the bottom at 1.0672. The level at 1.0895 moved higher and is now located at 1.0903. The bottom at 1.0672 is now located at 1.0512 and 1.0459.
Shorts must remain below falling 1.1143 and immovable 1.1155 to target the dynamic moving line now at 1.0903. A break of 1.0903 targets not only 1.0788 and 1.0775 but breaks here should see bottoms at 1.0512 and 1.0459. The range is found between dynamic lines at 1.0903 – 1.1143 and 1.1155.
Longs must break 1.1155 to target dynamic lines at 1.1275, 1.1288 and falling lines at 1.1594, 1.1598 and 1.1699.
Despite a severely oversold EUR/USD and a 2900 pip drop in 14 months, the economics of Europe and a Yellen raise are still grounds to continue focus on the downside. In terms of MA lines, the entire structure still reveals short as lines continue to descend. A full directional price change can only occur if Yellen rescinds a Fed Funds rate rise.
When EUR/USD last traded 1.0465 April 2015, the German yield curve was negative up to the 9 year yield and appeared to be trading below the deposit rate. German yields 1- 8 years viewed from a negative perspective is actually minus 0.119 but annualized then yields still remain far above the deposit rate at 0.88. The same interpretation can be seen in the European interest rate curve as minus 0.0515 transformed is actually 0.94 and again far above the deposit rate.
What’s striking is the German yield curve from 1- 10 annualized at 0.77 trades below the deposit curve and correlates 0.20 Vs the corresponding US 1- 10 year yield curve at 1.28, a difference of 0.51 from the six corresponding points. What explains the low Correlation and deviation is German Vs US swap rates at the 1 year yield remains positive 0.355 on the German side and negative 0.355 on the US side. German minus US and US minus German reveal a swap range between + 0.77 and Minus 0.77. If German yields are viewed in its entirety from 1 -10 then yields sit dead on the deposit rate. A break takes price to 0.75 as the range holds at 0.84. A break further determines if EUR/USD achieves the current yield forecast bottoms at 1.0512 and 1.0459. The 10 – 30 portion of the curve determines the EUR fate.
The 1- 30 German yield curve from 0.8748 again trades above the deposit rate and correlates vs the 1.65 US yield curve at 0.65, a difference of 0.77. The 10 – 30 drives both the German and USD yields as the correlation is 95%. The German mean at 0.96 vs USD at 2.55 reveal a spread of 1.59. The 1- 30 German range is 1.60 and 1.56 from swap rates between 1- 10 year.
Not only is EUR/USD at an important inflection point but the German curve is also at a critical juncture. If Yellen remains on hold, Draghi and the ECB may very well lower the Deposit rate. If Yellen raises then the work for Draghi will be done as the US spreads will widen Vs the Germans and should see a far drop for the EUR.
Brian Twomey, Inside the Currency Market, btwomey.com