EUR / USD gains stagnate at the key level of 1.2100 and the DMA of 21

• EUR / USD has been boosted by USD weakness but has stalled around 1.2100.
• The reasons for the dollar’s fall on Tuesday are unclear.
• But the improvement in the Italian political situation is helping the euro.

The EUR/USD has made the most of a further widespread decline in the US dollar fortune on Tuesday, although bullish momentum has stalled since European morning and the pair is now consolidating around the 1.2100 level, which also coincides with the 21 SMA.

On the day, the EUR / USD is trading with gains of around 60 pips or around 0.5% and is one of the best in the G10, only replaced on Tuesday by the safe haven currency duo CHF and JPY. The fact that these two safe-haven currencies are performing better in the G10 on the day is a testament to the fact that market sentiment is a bit more cautious on Tuesday; Equities and crude oil markets are taking a breather after consecutive days of gains since the beginning of last week.

Looking at the EUR / USD, ECB President Christine Lagarde and FOMC President Jerome Powell will speak on Wednesday and both are expected to reiterate that their banks will maintain their current highly accommodative monetary positions. Much more interesting will be the US consumer price inflation figures for January; Will the US see a rise in prices (perhaps) as large as the one seen in the Eurozone in January (unlikely)? A stronger-than-expected impression could well fuel the positive “reflation” narrative for risk assets and could hurt the USD.

Why is the US dollar falling?

So why is the safe-haven US dollar falling? It is impossible to give a definitive answer as no specific issue or new story can be pinpointed as the cause of Tuesday’s price action. Perhaps the small reduction in the short USD market position observed over the last few days has come to an end and the short positions are piling up again expecting a lower dollar in the coming weeks / months.

In fact, price action this week has given a sense of a return to “normal” (ie the USD is constantly under pressure, as it was for most of the second half of 2020). USD bearish arguments remain strong; As Fed officials continue to signal that the bank’s ultra-accommodative stance is going nowhere anytime soon, most expect real yields to remain low. Bullish asset risky narratives that more US fiscal stimulus is on the way and rapid vaccine launches will control the pandemic, setting the stage for a powerful global economic recovery and US demand is supposed to reduced tax havens will weigh on the world’s reserve currency, the USD. If all the additional stimulus from the US translates into a Fed needing to tighten up earlier than expected to cause inflation to rise faster and more persistently than expected, then it could be a positive dollar.

Euro basics

By changing the fundamentals of the euro, things are positive amid further improvements in the Italian political situation; the Bund-BTP spread (a measure of the Italian government’s perceived credit risk versus the German government’s credit risk) fell to its lowest levels since January 2016 and is well below 100 bp at the moment. Former ECB President Mario Draghi, who recently received a mandate from Italian President Sergio Mattarella to form a government, received conditional backing from the two largest parties in the Italian parliament over the weekend. More recently, the leader of the Forza Italia Party, Silvio Berlusconi, supported Draghi with the support of the party.

The markets are therefore betting that the former head of the ECB will be able to form a new government with a majority in parliament. Draghi is seen as a safe pair of hands and this, combined with his pro-European stance (he is said to want to push forward a common eurozone budget, the next step beyond the EU Recovery Fund which was funded by the joint issuance of debt), is taken as a positive euro.

Euro basics
By changing the fundamentals of the euro, things are positive amid further improvements in the Italian political situation; the Bund-BTP spread (a measure of the Italian government’s perceived credit risk versus the German government’s credit risk) fell to its lowest levels since January 2016 and is well below 100 bp at the moment. Former ECB President Mario Draghi, who recently received a mandate from Italian President Sergio Mattarella to form a government, received conditional backing from the two largest parties in the Italian parliament over the weekend. More recently, the leader of the Forza Italia Party, Silvio Berlusconi, supported Draghi with the support of the party.

The markets are therefore betting that the former head of the ECB will be able to form a new government with a majority in parliament. Draghi is seen as a safe pair of hands and this, combined with his pro-European stance (he is said to want to push forward a common eurozone budget, the next step beyond the EU Recovery Fund which was funded by the joint issuance of debt), is taken as a positive euro.

Elsewhere, the euro has generally been unaffected by mixed euro zone level 2 data; Germany saw stronger than expected trade figures released for December. The country’s trade surplus was slightly higher than expected at 16.1 billion euros, fueled by a surprise expansion in exports, which were supported by strong demand for products made in Germany from the United States and China. Other sectors of the German economy almost certainly contracted in December amid the tightening of national lockdown restrictions to curb the rise in Covid-19 cases. On the other hand, Italian industrial production for December was slightly weaker than anticipated, with economic activity in the sector registering a surprising 0.2% month-on-month drop versus expectations for a 0.3% increase.

Technical Levels