The EUR/USD consolidates before Wednesday's Federal Reserve meeting. Does correlation between the EUR/USD and other asset classes remain in place? The zloty is significantly stronger after Friday's fairly hawkish MPC meeting.
- No major macroeconomic data that may significantly affect the analyzed pairs.
What is the EUR/USD dependent on?
Until the ECB meeting on Thursday, key market assets generated similar signals. When stocks rose in the US, bonds were pushed higher in the States and the dollar appreciated; pushing the EUR/USD lower in anticipation of the Fed's more monetary tightening.
On one hand, the downside move on the EUR/USD was also justified by using the euro as a funding currency for the carry trade. The perspective of keeping the interest rates close to zero for the following years was a good argument to borrow in the euro and invest around the world.
On the other hand, when the global sentiment deteriorated and put back the Fed's hikes, the US treasury yields were also pushed lower and brought pressure to the dollar, lowering the future interest rate differentials between the US and the eurozone.
A significant disruption regarding this correlation was observed after the ECB meeting. The euro markedly gained value to the dollar. But since that moment, the global conditions haven't deteriorated. On the contrary, they have strengthened. Yields on two-year US bonds rose from around 0.88% to 0.96%. The S&P index increased at that time by around 1.5%. Treasuries and stocks have kept their positive correlation while the dollar hasn't.
Theoretically, this situation can be explained if the inflation expectations, measured by German two-year bonds, would have increased and tightened the spread between its US counter parts. But this also didn't happen. The German yields rose but still now remain at very low levels (negative 0.47%), a spread which is the highest in almost 10 years, at 1.43 percentage points.
Currently, there are point-of-view arguments that this trade can be significantly disturbed and can probably only short term volatility. This can produce a negative dollar correlation with the stocks and bond yields. The key currency market drivers for developed, high ranked economies – the interest rate differentials – remain in place.
Interesting Polish MPC meeting
The MPC’s decision to announce the decision to keep interest rates unchanged wasn't surprising. Almost all new members who commented on rates since the S&P rating cut, stressed that there is no need to change the monetary policy.
However, it is worth noting that two key elements for the MPC have recently changed. Firstly, the new inflation projections for 2016 were significantly lowered. Now, the central bank expects that prices will change to around negative 0.9 to +0.4% for 2016, while in November the NBP expected that the CPI would have been between +0.4% to 1.8%.
Secondly, on Thursday the ECB markedly loosened its policy. It should keep the interest rate disparity between the zloty and the euro at a fairly high level to increase the odds for capital inflow. In such a scenario, there are some expectations that the MPC may, at least slightly suggest that there would be some bias for the lower rates, even though the base case scenario is to keep them unchanged.
This didn't happen. So, we can conclude that the Friday's message was fairly hawkish. This is confirmed by the EUR/PLN reaction, which dropped toward 4.28 today. A stronger zloty also pushed the CHF/PLN to the level of 3.90. We can anticipate that if the global sentiment doesn't deteriorate, the EUR/PLN should be in the 4.25-4.30 range.