The Euro currency was able to rebound slightly at the beginning of the week, despite an interest rate differential that is pointing to a lower exchange rate. Weaker than expected economic data has pushed France into a recession. A lower currency could assist in an export led infusion which might assist the Euro zone growth prospects. Later this week the EU will release a number of economic data points including the German IFO, which is a business confidence index, along with the first look at May’s PMI data.
The yield differential which is a reflection of the forward rate curve in the EUR/USD currency pair is pointing to a lower spot price. The yield differential is calculated by subtracting the European 2-year yield from the US 2-year yield. With US yields hovering near 70 basis points, which is pegged by the Federal Reserve, the fluctuation comes from the decline in the European 2-year yield.
A declining differential makes it less attractive for investors to purchase the Euro currency and hold it relative to dollar rates. With economic activity in the EU pointing to a contraction, yield should continue to fall pushing the yield differential closer to zero. A close of the 2-year yield differential between Euro and the US rates below the 1.18 level would print the lowest low seen since February of 2011. Historically the 2-year yield differential and the currency pair are highly correlated which makes it likely that a declining yield differential will be followed by a declining currency pair.
This week’s economic data will likely generate further activity in both the yield differential and the currency pair. Market participants will need to absorb the EU initial manufacturing purchasing manager’s index readings for May on Thursday. The initial prints prior to the month end only include PMI reports for Germany and France and the EU as an aggregate. The April report showed a total PMI of 46.9 in April which is considered a print in contraction territory. The German PMI readings, which stood at 48.1 manufacturing and 49.6 services in April, will generate interest as Germany which was able to escape recession with a .1% in first quarter GDP.
The technical picture for the EUR/USD currency pair reflects the potential for a test of support levels. A break of the 1.2750 EUR/USD level would likely send the currency pair down to weekly support levels near 1.19.
The trend in the currency pair is negative as reflected by the 10-day and 40-day moving average. The 10-day moving average represents 2-weeks of trading while the 40-day moving average shows 2-months of trading. When the 10-day moving average crosses below the 40-day moving average, a medium term negative trend is considered in place. Additionally, momentum is negative. The MACD (moving average convergence divergence index) which show the change in moving averages is printing in negative territory and has a negative trajectory. The acceleration of negative momentum points to lower prices for the currency pair.