They say what goes up must come down. The euro found that out the hard way when it took a 200-pip dive below 1.3500 just after tapping 1.3700 last Friday. What the heck caused this move?!
Consequently, the selloff put an end to the euro’s 10-day winning streak against the dollar. Here are some reasons why EUR/USD fell yesterday:
1. Political uncertainty in Spain
Political instability and risk appetite never go well together, much in the same way as beer and ice cream combined leave you with a nasty tummy ache. Yesterday, news broke out that Spanish Prime Minister Rajoy is facing opposition calls for him to step down. The Spanish leader has been accused of receiving under-the-table illegal payments.
Of course, Rajoy was quick to deny such allegations. He toned them down by saying that these are coming from those who only want to damage his party.
Whether there’s any truth to the rumors or not, investors didn’t like any bit of it. Remember that Rajoy was able to implement the harshest austerity measures in Spain, helping the country put its balance sheets in order and lower borrowing costs. The possibility of Rajoy leaving office caused Spanish 10-year bond yields to jump 22 points to 5.43% yesterday.
2. Prospect of hung parliament in Italy
Another factor that weighed the euro down during yesterday’s trading was the increasing possibility of a political stalemate in Italy. Recent opinion polls revealed that the gap between Italy’s opposing parties, center-right coalition led by former Prime Minister Berlusconi and the ruling center-left party led by Mario Monti, is narrowing ahead of the general elections later this month.
If neither party is able to secure a strong lead against the other, Italy could end up with a hung parliament, which could delay the country’s progress in achieving financial reform. After all, current Prime Minister Monti’s popularity has been slipping as Italians are unhappy about ongoing tax hikes and austerity measures. Berlusconi, Italy’s infamous “Bad Boy”, took this chance to gain some popularity points by announcing his plans to implement tax breaks and repeal Monti’s controversial real estate tax.
A lot can still happen before the actual elections on February 24-25 but the prospect of political uncertainty was enough to push Italian bond yields up by 10 basis points to 4.42% early this week.
3. EUR/USD is due for a correction
The political factors I mentioned earlier may have been the catalysts for EUR/USD’s retreat but technical analysts have long been pointing out that the pair was due for a correction sooner or later.
The euro has climbed nearly 7% against the U.S. dollar in just a span of two months as it surged from the 1.2900 area in December last year to the 1.3700 handle last Friday. In fact, EUR/USD is trading close to its long-term average but still within the ECB‘s comfort zone of 1.3400 to 1.3600.
With the ECB rate decision coming up later this week though, market watchers will be conscious of any remarks concerning the euro’s recent gains. A few years back, former ECB head Trichet used to refer to such strong rallies as “brutal” and traders typically interpreted this to mean that the central bank was ready to intervene in the currency market.
Whether EUR/USD’s recent selloff is just a retracement or the start of a reversal remains to be seen, and it seems that the pair’s fate rests on the outcome of the upcoming ECB statement. I’ll keep you posted as the event draws near so stay tuned!