EUR/USD’s position today and since Yellen’s Fed Funds raise and Draghi cut is exactly neutral. Neutrality through my interest rate models means, daily, 1 month, 3M, 6M and 1 year. Why. ECB and Fed Monetary policies converged rather than diverged as all the market people claimed. Prior to Draghi’s cut, Eonia V Fed funds stood at 0.8 V 0.15, a 65 Bps wide channel. Then Draghi cut to 0.70 while Fed Funds stands at 0.36, a 34 bps wide channel and a 31 bps convergence. if Yellen refused to cut then the channel would’ve stood at 55 bps and no big deal to continued EUR/USD downtrend.
We have convergence on our hands, not divergence. For all the stories about divergence, USD will do X, past USD acted like X in past cycles were all wrong. The 0.50 Fed Funds, 0.05 in ECB’s Fixed Rate and 0.30 in the Marginal Lending Facility is pablum information as it doesn’t drive markets or exchange rates. Interest differentials actually favor EUR/USD as Yellen’s raise and present convergence dead stopped EUR/USD’s downtrend.
Further to neutrality, European interest rates short term are in correct positions while long end positions still have light years to travel downward. Viewed from 1 year, every European interest rate is severely oversold as model averages are still adjusting to the first September 2014 ECB cut to 0.80. Long and short ends in European interest rates are fighting against each other in daily, monthly, 3 and 6m time frames to offer a further neutrality conundrum.
Convergence and neutrality means not a trend but slow price movements where tops are sold and bottoms bought to allow a price to remain in perfect neutrality until a market event breaks the deadlock. To define neutrality further, curves at the short end since yellen and Draghi offer about 18 pip ranges while long ends offer about 70 pips. Draghi cut at the exact time when the first September 2014 decrease was finally reflected in the market. Short ends now reflect the new cut while the longer ends will take much time, possibly 1 year to adjust.
Why intent focus on EUR is because EUR still offers the widest ranges among its peers. GBP/USD offers 31 and 27 pips between long and short ends while AUD and NZD offer 10 and 15 pips each. EUR/USD remains the pair to trade as it will outperform its counterparts despite its neutrality position. Points holding EUR/USD are 1.0850 – 1.0865 below and 1.1060’s above. Then comes the 1 year average at 1.1115 while a break of 1.0850’s would not only see the downtrend resume but 1.0700’s and 1.0600’s should be seen quickly.