Better Data, Higher Inflation Expectations Lifting Yields And Euro In Short-term

Fundamental Forecast for Euro: Neutral

– Euro rally built on US Dollar weakness, improved Euro-Zone data translating into higher yields.

– Markets may be thinking ECB is behind the curve after recent data surprises.

– See the DailyFX Economic Calendar for the week of October 30 to November 4, 2016.

The Euro had quite a strong week on approach to the end of October, finishing higher against all of the major currencies covered by DailyFX Research. EUR/USD’s gains could be considered modest (+0.92%), relative to the performances by EUR/JPY (+1.81%), EUR/CAD (+1.41%), and EUR/GBP (+1.32%). Whereas EUR/USD weakness arrived late in the week on the back of headlines pertaining to the US Presidential election, Euro strength, generally speaking, was evident for most of the week as it appears markets are casting doubt on the European Central Bank’s dovish outlook.

Whereas the initial Euro rally after the ECB’s October policy meeting was quelled, thanks in large part to ECB President Mario Draghi himself outlining the path to a shift in the QE program in December, last week’s gains reflect a mindset that the market may believe the ECB is falling behind the curve. A look at the recent rise in the German Bund 10-year yield illustrates this point, having gained +32.8-bps in recent weeks to 0.167% by market close on Friday.

Supporting the recent rise in European yields (reflecting credit weakness and/or discounting future ECB policies) has been a sharp jump higher in economic data trackers during the month of October. Analysts and economists, riding the coattails of the ECB’s policy forecasts, may have been too pessimistic in their expectations for data: the Citi Economic Surprise Index for the Euro-Zone jumped to +43.5 on October 28 from a mere +2.6 on September 30.

Concurrently, with data generally perking up more than anticipated, Euro-Zone inflation expectations have run to their highest level since June 1. 5-year, 5-year inflation swaps now yield 1.477%, up sharply during the last month from +1.355% on September 30. It bears mentioning that this medium-term market gauge of inflation is still well-below the ECB’s medium-term target of +2%, but the recent rise may be due to incoming base effects thanks to energy prices.