Euro to propel on relapsing EU inflation & US jobs data
Fighting inflation is hard. Hence, central banks are data dependent while calibrating rates. Continuing geopolitical conflicts puts Europe at risk of inflation relapse.
Headline numbers can be misleading. Central bankers will dig deep. Deeper analysis will compel investors and policy makers to rethink and recalibrate interest rate calculus.
This paper unpacks US jobs & Euro area inflation report, and market expectations of rates ahead.
UNPACKING US NON-FARM PAYROLL DATA
The US labour market added 216k jobs in December 2023 surpassing expectations. It was up 25% month-on-month.
Headline numbers look healthy. Details spell trouble. Payroll data was revised lower by 71k for October and November. Average work week contracted, and participation rate declined.
Jobs growth is concentrated in three sectors, namely, Government, Education/healthcare, and Leisure/Hospitality. Eighty percent of the jobs added are from sectors that are not considered growth engines.
Three key takeaways from jobs report:
1. Employment growth remains robust: Month-on-Month employment trends point to jobs growth in government, leisure and hospitality, health care, social assistance, and construction, while transportation and warehousing lost jobs.
On a 12-month seasonally adjusted basis, apart from (a) Transportation & Warehousing and (b) Information, rest of the sectors added jobs.
2. Hourly Wage Earnings growth is strong: In December, average hourly earnings on private payrolls jumped by fifteen cents, or 0.4%, to USD 34.27/hour. Average hourly earnings have increased by 4.1% over the last year.
3. Unemployment Remains Unchanged: Unemployment rate was unchanged at 3.7% (3.5% last year this time) with number of unemployed persons unchanged at 6.3 million (5.7 million last year this time).
COMPREHENDING EUROZONE INFLATION NUMBERS
Euro area inflation rose 2.9% YoY in December 2023, reversing a two-year low (2.4%) observed in November. Eurostat inflation estimates was marginally below the market consensus of 3%. Inflation uptick since April 2023 was primarily due to energy-related base effects.
Energy prices declined 6.7% while services inflation was flat. Core inflation, excluding food and energy prices, softened to 3.4%. Core inflation is at its lowest point since March 2022.
MARKET EXPECTATIONS OF RATE CUTS
Investors are betting that the US Fed and the ECB will cut rates six times this year. First rate cut is expected in March or April.
Market expectations are in sharp contrast to policymakers. The US Fed expects to make three quarter-point cuts this year. The ECB has stood its ground arguing that the inflation fight is not over yet.
Amid strong economic data, probability of Fed rate cuts in March has fallen from 100% to 70%.
EUR-USD WITNESSED WILD MOVES ON INFLATION, JOBS, AND SERVICES DATA BUT SETTLED WHERE IT OPENED
Last Friday news flow impacting FX rates were strong. Front month EUR-USD futures traded wildly opening at 1.0977 reaching a high of 1.1030 and then plunging to a low of 1.0908 before closing at 1.0977.
December US ISM Services PMI unexpectedly fell to 50.6, the lowest reading in seven months, compared to 52.7 in November. Services industry is critical accounting for more than two-thirds of the US economy.
Euro fell 0.5% last week, marking its largest weekly drop since early December breaking three consecutive weeks of strengthening.
The EUR-USD is hovering at its support levels with the 50d DMA likely to print a golden cross with the 200d DMA.
Near term technical signals point to strengthening of the Euro versus the US dollar. Momentum favours Euro while price reversion risk remains neutral.
Diverging macroeconomic conditions leaves Eurozone exposed to higher risk of inflation relapse. The ECB is expected to be slower with rate cuts relative to the Fed. In anticipation, leveraged funds are starting to sharply reduce their net short positions in the CME EUR/USD futures.
HYPOTHETICAL TRADE SETUP
Europe is at greater risk of inflation relapse on continuing geopolitical risks in Russia-Ukraine and the middle east. Energy and goods inflation relapse will force the ECB to defer its rate cuts.
Size of the rate cuts, if any, is also likely to be smaller at the ECB relative to the Fed. This will strengthen the Euro against the USD in the near term.
To harvest gains from a strengthening Euro, this paper posits a hypothetical long position in CME Micro EUR/USD Futures expiring in March 2024 (M6EH2024) with an entry at 1.0979 combined with a target at 1.1123 and hedged by a stop at 1.0871, delivering an expected reward-to-risk ratio of 1.33x.
Each lot of CME Micro Euro Futures contract provides exposure to 12,500 Euros. It is quoted in USD per Euro increment. Each pip i.e., 0.0001 per Euro delivers a P&L of USD 1.25.
• Entry: 1.0979
• Target: 1.1123
• Stop: 1.0871
• Profit at Target (hypothetical): USD 180 (= 0.0144; 144 pips; 144 x 1.25 = 180)
• Loss at Stop (hypothetical): USD 135 (= -0.0108; -108 pips; -108 x 1.25 = -135)
• Reward-to-Risk (hypothetical): 1.33x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Headline numbers can be misleading. Central bankers will dig deep. Deeper analysis will compel investors and policy makers to rethink and recalibrate interest rate calculus.
This paper unpacks US jobs & Euro area inflation report, and market expectations of rates ahead.
UNPACKING US NON-FARM PAYROLL DATA
The US labour market added 216k jobs in December 2023 surpassing expectations. It was up 25% month-on-month.
Headline numbers look healthy. Details spell trouble. Payroll data was revised lower by 71k for October and November. Average work week contracted, and participation rate declined.
Jobs growth is concentrated in three sectors, namely, Government, Education/healthcare, and Leisure/Hospitality. Eighty percent of the jobs added are from sectors that are not considered growth engines.
Three key takeaways from jobs report:
1. Employment growth remains robust: Month-on-Month employment trends point to jobs growth in government, leisure and hospitality, health care, social assistance, and construction, while transportation and warehousing lost jobs.
On a 12-month seasonally adjusted basis, apart from (a) Transportation & Warehousing and (b) Information, rest of the sectors added jobs.
Source: BLS
2. Hourly Wage Earnings growth is strong: In December, average hourly earnings on private payrolls jumped by fifteen cents, or 0.4%, to USD 34.27/hour. Average hourly earnings have increased by 4.1% over the last year.
Source: BLS
3. Unemployment Remains Unchanged: Unemployment rate was unchanged at 3.7% (3.5% last year this time) with number of unemployed persons unchanged at 6.3 million (5.7 million last year this time).
COMPREHENDING EUROZONE INFLATION NUMBERS
Euro area inflation rose 2.9% YoY in December 2023, reversing a two-year low (2.4%) observed in November. Eurostat inflation estimates was marginally below the market consensus of 3%. Inflation uptick since April 2023 was primarily due to energy-related base effects.
Energy prices declined 6.7% while services inflation was flat. Core inflation, excluding food and energy prices, softened to 3.4%. Core inflation is at its lowest point since March 2022.
MARKET EXPECTATIONS OF RATE CUTS
Investors are betting that the US Fed and the ECB will cut rates six times this year. First rate cut is expected in March or April.
Market expectations are in sharp contrast to policymakers. The US Fed expects to make three quarter-point cuts this year. The ECB has stood its ground arguing that the inflation fight is not over yet.
Amid strong economic data, probability of Fed rate cuts in March has fallen from 100% to 70%.
Source: CME Fedwatch Tool
EUR-USD WITNESSED WILD MOVES ON INFLATION, JOBS, AND SERVICES DATA BUT SETTLED WHERE IT OPENED
Last Friday news flow impacting FX rates were strong. Front month EUR-USD futures traded wildly opening at 1.0977 reaching a high of 1.1030 and then plunging to a low of 1.0908 before closing at 1.0977.
December US ISM Services PMI unexpectedly fell to 50.6, the lowest reading in seven months, compared to 52.7 in November. Services industry is critical accounting for more than two-thirds of the US economy.
Euro fell 0.5% last week, marking its largest weekly drop since early December breaking three consecutive weeks of strengthening.
The EUR-USD is hovering at its support levels with the 50d DMA likely to print a golden cross with the 200d DMA.
Near term technical signals point to strengthening of the Euro versus the US dollar. Momentum favours Euro while price reversion risk remains neutral.
Diverging macroeconomic conditions leaves Eurozone exposed to higher risk of inflation relapse. The ECB is expected to be slower with rate cuts relative to the Fed. In anticipation, leveraged funds are starting to sharply reduce their net short positions in the CME EUR/USD futures.
Source: CME QuikStrike
HYPOTHETICAL TRADE SETUP
Europe is at greater risk of inflation relapse on continuing geopolitical risks in Russia-Ukraine and the middle east. Energy and goods inflation relapse will force the ECB to defer its rate cuts.
Size of the rate cuts, if any, is also likely to be smaller at the ECB relative to the Fed. This will strengthen the Euro against the USD in the near term.
To harvest gains from a strengthening Euro, this paper posits a hypothetical long position in CME Micro EUR/USD Futures expiring in March 2024 (M6EH2024) with an entry at 1.0979 combined with a target at 1.1123 and hedged by a stop at 1.0871, delivering an expected reward-to-risk ratio of 1.33x.
Each lot of CME Micro Euro Futures contract provides exposure to 12,500 Euros. It is quoted in USD per Euro increment. Each pip i.e., 0.0001 per Euro delivers a P&L of USD 1.25.
• Entry: 1.0979
• Target: 1.1123
• Stop: 1.0871
• Profit at Target (hypothetical): USD 180 (= 0.0144; 144 pips; 144 x 1.25 = 180)
• Loss at Stop (hypothetical): USD 135 (= -0.0108; -108 pips; -108 x 1.25 = -135)
• Reward-to-Risk (hypothetical): 1.33x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs tradingview.com/cme/.
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
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