US Dollar, Euro: Who Needs Intervention When You Have ECB President Trichet?

If you didn’t believe the US dollar could last on Thursday, you probably changed your mind on Friday as the US dollar rally went on undisturbed and broke through critical resistance levels.

Indeed, versus the Euro, the US dollar broke above the 200 SMA – an average that has served as strong support and resistance in the past – while the US dollar index surged above a rising trendine connecting the March, May, and June highs. Furthermore, as Quantitative Analyst David Rodriguez mentioned yesterday, forex positioning shows that traders are still selling the greenback across the majors. As a contrarian indicator, this points toward further US dollar gains. Just a few weeks ago, the currency was trading at record lows and speculation was mounting over what the possibility of physical or verbal intervention by the US.

However, ECB President Trichet has proven to be the tried-and-true market mover of the year, as his commentary following the European Central Bank’s rate decision on Thursday was really was drove this move by turning interest rate expectations in favor of the US dollar. Currently, the ECB holds their key rate at 4.25 percent while the Fed holds theirs at 2.00 percent. Two weeks ago, overnight index swaps were pricing in 16.5bps worth of rate hikes by the ECB within the next year and 64bps worth of increases by the Fed, which was on net EUR/USD positive. Now, though, swaps are pricing in almost 30bps worth of rate [I]cuts[/I] by the ECB and 78bps in rate hikes by the Fed. Since the forex markets are driven primarily by interest rates, the shift in expectations was more than enough to spark the US dollar bullish breakout witnessed on Thursday and Friday.

With economic indicators in the Euro-zone only anticipated to deteriorate further, especially as next week’s Q2 GDP report is forecasted to reflect a 0.2 percent quarterly contraction, the Euro is likely to remain a laggard in coming weeks. Does this mean the US dollar has bottomed out versus the Euro? Not necessarily, but for now, [B]the trend for EUR/USD is down and it is not a move to be ignored[/B].