Deutsche bank today addresses the question of US Vs EU rate differentials and a concept highlighted here weeks ago for many currency pairs. Long ago was also mentioned interest rate changes were coming and an imperative to learn how to prepare for the day now upon us. As we remain ahead of any curve especially interest rates, my own advice led 2 years ago to the most robust, accurate designed interest rate trading system. I’m long ready for these central bankers.
The current EU /US differential runs 53 basis points. This figure is light from a trading / volatility perspective yet its not terrible. If Yellen raises again and the ECB refrains then the differential climbs to 65 and volatility will be good, not great as the old days but good enough. A Yellen raise however might force the ECB higher in which case the differential remains the same as today at 53. An ECB raise and Yellen on hold means the differential closes to 41 and volatility literally disintegrates. The old days of EU /US differentials was right at 75 to offer a perspective of 53.
An ECB raise would force Denmark, Norway, Sweden and Switzerland higher so to cut the differentials. Central banks want differential contraction rather than expansion so to control / manage the exchange rate. Last aspect a central bank wants is the exchange rate to reach unintended levels as possible and expensive interventions might be seen. In this regard, the BOJ and its current economic experiment would come under severe threat as the Japanese differential sits directly between the US and EU. The Japanese would be forced to move interest rates.
Under any interest rate change however is the assumption normalization is here and the future economic orientation is bright. I’m not among those to see normalization in economics or interest rate changes ready for prime time. Nor do I see the need to raise ahead of any future economic forecasts. Yellen’s inverted yield curve marks the example. What effects other yield curve shapes look like is unknown in comparison.
The German 10 to 30 spread runs 0.77 Vs 0.19 for the 10 to 3 month. !0’s and 5’s as well as 10 to 2’s remain deeply negative. Draghi is not ready to raise as he risks a possible inversion to flat yield curve.
EUR/USD today must breaks below are located at 1.1403 and a tough area. Then comes 1.1388, a big break at 1.1382 and on to the bottom at 1.1374. Should today’s US CPI release report out of sync then 1.1352 and 1.1323 comes next. EUR/USD remains far overbought and targets longer term are located at high 1.1200’s to start.