Summary:

• US dollar has untapped potential from higher bond yields
• technical analysis indicates that a correction is a possibility on EURUSD
• Wage growth at 3% could be a big trigger for the greenback 

The US currency had a dismal year 2017 and this year started in similar moods. Trade Wars rhetoric initiated by White House did not help and contradicted assurances that the administration wanted “strong dollar”. Therefore the greenback slipped even as the Fed continued increasing interest rates. Could the NFP report change it?

Downside to be unlocked?

Let’s start from fundamentals. We’ve seen a major rise in yields of the US bonds and a corresponding spread to German bunds but it did not help the dollar or did not prevent an ascent of the EURUSD. EURUSD used to track a 10-year bond yield spread fairly closely for years so the scale of a present disconnect looks somewhat puzzling. Explaining possible reasons behind this divergence is beyond a scope of this analysis so we just conclude that it could herald a downside for the pair, should market participants pay more attention to bond yields again. 

There’s a huge disconnect between EURUSD and a 10-year bond yield spread. Source: Bloomberg, XTB Research 

Technical analysis – signs of exhaustion?

EURUSD is in the upwards trends on D1/W1 intervals regardless of how would you look at it. The question is though – could that trend be sustained? On the W1 chart we can see a significant consolidation zone between 1.21 and 1.25 and while this could be just a pause in a trend do notice that weekly candles have mostly upper shades. That means that upward intra-week impulses were quickly countered by sellers – not exactly a sign of strength. 

There are signs of weakness of a weekly time-frame. Source: xStation5

On a D1 frame we can see a strong upwards channel with prices testing a lower limit. However, there are many numbers to pay attention to. Firstly – the whole expansion reached 61.8% retracement of a huge bear market that lasted until early 2017. Second, the bull market that’s more than one year old has pretty much reached 112% range of a similar move from 2012/13. Both of these numbers happen to be in high 1.25s marking a possible reversal. A plunge through a lower limit could see a test of 1.20. 

A lower limit is being tested on the EURUSD. Source: xStation5 

3% – the magic number

We had some strong indications from the US labour market – the ADP report showed another healthy gain in private employment (241k after 246k in March – both were higher than expected). The ISM services, while missing the consensus narrowly on the headline level, showed an increased pace of hiring (the component increased from 55 to 56.6 pts.). However the focus is on wage growth where we have not seen the 3% number since early 2009! January was close at 2.9% (revised downward to 2.8% last month) but February saw a dip to 2.6%, partly on a high base from last year. Could the 3% be achieved and renew speculations about 4 hikes this year? Our answer is: yes but not this time. The consensus is at 2.7% and that should be achieved easily. The base effect improved by nearly 0.2pp so that would imply a reading of 2.7-2.8%. The base effect will keep on improving slightly all the way through the summer so if we see a small build in wage pressures a 3% reading is very much possible in the second quarter. The report is about to be published on Friday, 1:30 pm GMT.

Higher wage growth is required to promote inflation recovery. Source: Macrobond, XTB Research