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The Big Question This Week: Is the Euro Too Strong?

Fundamental Forecast for EUR/USD; neutral

The ECB meeting this week won't produce any substantive change in policy, although the press conference could bring dovish commentary from president Mario Draghi.

EURO strenght has become a concern for policymakers in recent weeks, and its nearly 5% above the ECB's 2017 year-end expectation of 1.1700.

-the IG client sentiment index is no longer bullish on EUR/USD in the near-term. 

the Euro's hot streak versus the us dollar finally started to cool off last week,with the pair slipping back by 0.16% despite the US government being   on the precipice of a shutdown. but gains were still widespread elsewhere, with five of the seven major EUR-crosses turning in positive performance over the past five days: EUR/AUD added +0.82 and EUR/GBP gained +0.78%.

after a week in which the December European Central bank policy meeting minutes signaled some intent to wind down the QE program sooner than previously anticipated, ECB policymakers came out to remind market participant that they're not going to let EURO appreciation run unchecked ECB vice President Vitor Constantino and Governors Francois Villeroy de galhau and Ewald Nowotny all suggested that sustained strength in the Euro exchange rate could become an obstacle in the fight to get inflation back to the medium-term target. This seems to led to the key question heading into the ECB rate decision this week: will the Euro's otherwise unchecked strength in 2018 provoke a change in tone from president Mario Draghi?.

"The market is accustomed with what is taking place in U.S. politics. it is not reading too far into the shutdown, which is more like a politcal show," said Koji Fukaya, president of FPG securities in Tokyo.

 the dollar index against a basket of six other major currencies initially    dipped to hit 90.155 but was last up 0.07 percent at 90.634, managing to hold above the three through of 90.113 set on Thursday

 The  euero was mostly flat at $1.2227 after dipping to $1.2275, and failing to regain a three-year peak of $1.2323 that it scaled on Wednesday.

"The dollar's losses have been limited as negotiations going into Friday were proving difficult and the market had time to price in a U.S. government shutdown," said shin kadota, senoir strategist at Barclays (Lon:BARC) in Tokyo.

"The shutdown is also not expexted to last a very long time. That said, if the shutdown stretches out to several weeks, then we would have to start worrying about the negative impact on the U.S. economy"

The dollar pared its earlier losses and was little changed at 110.810yen, still some distance from a four-month low of 110.190 plumped on Wednesday.

 

"A reverse correlation has been in place for a while between Treasury yields and the dollar, but there are sighs that the disconnect between the two is finally beginning to reverse,"Fukaya at FPG securities said.

 The Australian dollar was little changed at $0.7989 and the New Zealand dollar was steady at $0.7277.

The pound dipped 0.3 percent to $1.3862, pulling away from a 1-1/2- year top of $1.3942 reached on Wednesday following Friday's disappointing UK retail sales data. 

Before Friday's fall sterling had gained against the dollar for seven straight sessions, with traders welcoming positive noise from the European Union about Brexit negotiations.

Market measure of inflation continue to trend higher, and with the 5-year, inflation swap forwards, one of ECB president Draghi's  preferred gauges of inflation, closing last week at 1.765%- its highest level since February 21, 2017. For now, the Euro hasn't interfered with the broad uptick in inflation expectations, and so long as energy prices continue to sustain their strenght, market participants don't appear to be  committed to saying the Euro's rise is that much of an issue.