Unlike the Dollar, the Euro Could Gain on Stronger Inflation

(Bloomberg) -- In financial markets where textbook correlations seem to be breaking down, traders should find they can still depend on the one between the euro and inflation.

The dollar’s counter-intuitive move south despite stronger-than-forecast U.S. price data showed investors see the currency in a medium- to long-term downtrend on the back of twin-deficit concerns. In contrast, the common currency is free of such complications. A strong euro-area inflation print on Feb. 23 should signal hawkish revisions to the European Central Bank’s price and growth projections next month, thus taking policy makers one step closer to ending their bond-buying program and ticking another box for euro bulls.

Unlike the Dollar, the Euro Could Gain on Stronger Inflation

In a sign of its potential, the euro moved above $1.25 once more on Thursday as traders added long exposure having been underweight the common currency after the stock rout brought a washout in short-term positioning.

Still, it may not be all plain sailing. While the U.S.’s fiscal and current-account deficits spell more trouble for the dollar, the euro needs its path higher cleared by the ECB meeting on March 8. Even though some Governing Council members have telegraphed a need for the central bank to raise interest rates, a language shift by President Mario Draghi himself is probably needed to convince the market that September will indeed mark the end of QE.

Unlike the Dollar, the Euro Could Gain on Stronger Inflation

Technically, the biggest hurdle for the euro is the resistance area near $1.2700, where the upper end of the currency’s bearish trend since its 2008 highs lies currently. A test of that area before the ECB meeting may prompt some verbal push back from officials, yet euro bulls might raise their eyebrows with disbelief once more.

A weak euro-area inflation reading could see buying interest by interbank and leveraged names around $1.2300 come under pressure, but amid this dollar-negative environment, they may hold with little effort.

What to Watch:

  • Feb. 19 will probably see thin liquidity as U.S. stock and bond markets are closed due to Presidents’ Day national holiday
    • Euro-area finance ministers will vote in Brussels for the ECB’s next vice president
  • The next day, Swedish Central Bank Governor Stefan Ingves speaks on monetary policy
  • Federal Reserve to release minutes of its January meeting on Feb. 21
    • Bank of England Governor Mark Carney testifies on February Inflation Report
  • Feb. 22 highlights include speeches by New York Fed President William Dudley and Atlanta Fed President Raphael Bostic
    • The following day, Cleveland Fed President Loretta Mester and ECB Executive Board member Benoit Coeure speak at the U.S. Monetary Policy Forum in New York City
  • Euro-area PMIs, U.K. employment and GDP data, U.S. leading indicators also due; see data calendar

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