On July 9 in Monetary Monitor, our exclusive client-only publication, we said:

“Overall, markets continue to like the risk-on trend, but less and less so. The biggest driver in FX moves this year will likely be the divergence in the monetary policy of the US versus the rest of the world. Since the start of 2021, we have been one of the few voices calling for a stronger dollar versus other major currencies while also favoring reflation trades. However, we turn more cautious on reflation trades at this juncture, particularly commodities and commodity-related FX. We still think US equities have a foothold to be a strong performer, along with the US dollar versus the euro and yen.”

With the ECB meeting concluded today, we are beginning to see the beginning of monetary policy divergence. As we outlined yesterday, the meeting was nothing of a surprise to us- as we outlined yesterday, we expected a dovish ECB on the back of its new symmetric inflation target. At the press conference, Lagarde’s choice of words was interesting to us, particularly that there may be a period where inflation could run above target- much like the Fed. However, unlike the Fed, the ECB will have to keep monetary policy accommodative for long after 2021 to achieve this target on a sustainable basis. As a result of these policy dynamics, EURUSD was largely weaker today:

As we can see above, the weaker euro was enough to contribute to dollar strength. However, this was generally contrary to the major trend today, with most major regions attracting capital away from the dollar:

The sum of all these capital flows largely resulted in a deflationary tilt to asset pricing in global markets, which we show below via our Global Market Regime Monitor:

We largely think that the slowing inflation leg of current market pricing is here to stay, even if the EU experiences higher inflation rates. Further, US growth will outpace EU growth in levels and quality- thereby attracting capital away from the EU to the US. Finally, the monetary policy divergence between the EU and the US has started to show, and we think there’s further to go from here. Overall, the setup isn’t positive for EURUSD, which continues to have strong downwards momentum, albeit looking a little cheap:

As a refresher on our lenses:

  • Trading Range: These ranges represent a trading bank within which a currency should trade based on multiple market factors. If we are long- prices above the upside range indicate the asset is expensive, and prices below the downside range suggest that they are cheap and vice versa if we are short.
  • Year-to-Date Returns: This is the price performance of a given currency over the course of the current calendar year, in percentage terms. We also compare the current price to the 52-week high and low for reference.
  • Price Momentum: This looks at cumulative rolling returns for a selected lookback period.  Positive momentum is good if we are long and bad if we are short. 
  • Implied Volatility Discount/Premium: This tells us what the market expects in volatility relative to the history of volatility. If we are long a currency, we typically want market implied volatility to be higher than historical volatility and vice versa if we are short.

As a reminder- it is not just enough to have the technical tools we provide here daily. Head to https://www.fxdd.com/mt/en to get access to our research and analysis! You need to know the fundamental developments in markets that are driving these moves promptly.