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1. EURUSD – New regime, old policy error

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Macro has flipped bearish on inflation and ECB risk; but EURUSD is already discounting part of it and screens as cheap.

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EURUSD ended last week 1.5 sigma cheap on Qi. That’s very much the cheap end of the recent Fair Value Gap range. The single currency has rallied this week but still sits slightly below macro-warranted fair value, which now sits around 1.1550.

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FVG aside, the EURUSD model is notable because:

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we’re back in regime. From mid-Jan and through February, non-macro factors drove price action. But model confidence is now 67% & we have a new macro regime.

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The biggest driver of this new regime is inflation differentials. The oil spike has pushed inflation expectations higher globally, but the impact is greater in Europe. On Qi, the relationship is negative, so this has dragged EURUSD macro fair value lower.

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Put another way, the single currency has been punished for fears the ECB will hike rates into a slowing economy. The fx market viewed that as a potential policy error & Euro negative. ECB rate hikes don’t benefit the currency but hurt it.

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The bad news is that inflation differentials explain a third of our model - as long as markets fear this is the ECB policy response, macro momentum in EURUSD will favour the downside. The consolation is, to a degree, some of that bad news is already in the price.

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Continue reading our analysis on the other headlines by downloading the PDF below

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