The market delivered relatively severe position adjustment in January that weakened the Dollar versus the Euro by around 2%. Position adjustment allowed the more defensive, long USD, positioning built up into year-end to be unwound. Data showing FX market positioning now available up to 25th January showed that aggregate dollar positioning shifted to its lowest since September 2021. This represented a rebalancing of USD into the important 26th January FOMC meeting. As we have covered, this even saw a far more hawkish than assumed Jay Powell signal policy tightening over tapering just around the corner and present a case to be wary of inflation.
It was the rebalancing in USD positioning associated with the so-called long squeeze that allowed the Dollar to pick up a further two percent versus the Euro and for EURUSD to reach lows not seen since 2020. The pair also found technical support, breaking below the 50-day moving average following the Federal Reserve meeting. Momentum has changed in recent sessions and the now re-appearing 50-day resistance will prove important ground to watch.
Part of the reason for the retracement in EURUSD has been derived from the outcome of elections in Italy and concern over a data heavy week for the US. Italy is set to be the biggest winner from the EU’s pandemic recovery fund. However, in order to release each tranche of the funds it has to demonstrate progress on a package of reforms it has pledged to adopt. During Mario Draghi’s short tenure, some relatively severe reforms have been front loaded. Even if Draghi had secured the Presidency, his absence from the Prime Ministership could have left a vacuum in parliament that could have jeopardised the progress of planned reforms and thus support.
Sergio Mattarella might not have secured a second term in the smoothest of ways and the plea and bargaining that delivered Italy’s incumbent president a second term over the weekend may not have been pretty. However, it still allows a continuity within Italian politics that markets have welcomed. Accordingly, BTP spreads have tightened significantly from 142-points pre-agreement to 130 points today. This indicator signals more moderate Eurozone risk has in turn supported the Euro. It is sure, however, to be a US Dollar story that will determine more significant deviations from current EURUSD spot values.
Discussion and Analysis by Charles Porter