What Are The Markets Facing?

Friday’s economic calendar will be very light, and while the release of German producer prices could be market-moving for European assets, the impact may be very short-lived since the news will focus on one specific economy, rather than the entire Euro-zone. Producer prices in the Euro-zone’s largest economy are expected to rise 0.7 percent during the month of June, pushing the annual rate of growth up a more than 26-year high of 6.5 percent. Indeed, raw material prices have skyrocketed in the commodity boom, especially when it comes to the cost of oil. In fact, surging energy prices have been the primary driver of gains in the German producer price index during recent months, and given the rise in crude above $140/bbl during June, this reading is unlikely to be any different. If the index actually shows a stronger-than-expected rise, the traders will be quick to recall European Central Bank President Jean-Claude Trichet’s hawkish bias, especially as he said just last week that inflation had hit “worrying” levels. On the other hand, Mr. Trichet also said that following the 25 basis point rate hike enacted earlier this month, “the monetary policy stance will contribute to achieving price stability over the medium term.” As a result, a softer-than-anticipated producer price reading will add to expectations that the ECB is done raising rates.

Bonds – 10-Year German Bund Futures

Since forming a double-bottom at 109.65 in June, Bunds have rallied quite a bit. However, the contract has simply consolidated around 112 over the past week or two, as traders weigh the odds of further tightening of monetary policy by the ECB. As a result, the release of German producer prices are likely to weigh Bunds below near-term support at 111.50 as the index is likely to add to the ECB’s inflation concerns. On the other hand, weaker-than-expected reading could keep Bunds within range to rise toward 112.

FX – EUR/USD

EUR/USD hit a new record high on Tuesday morning of 1.6038, but has subsequently backed off since then as the US dollar staged a recovery on the back of commentary by Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson, along with significantly stronger-than-expected US CPI figures. Looking ahead to Friday, the release of German producer prices could spark some volatility in EUR/USD for a short period of time during the morning as the index will likely indicate that upside inflation risks continue to grow. If the figures prove to be stronger-than-expected, EUR/USD could rise toward 1.59. On the other hand, if prices rise less-than-forecasted EUR/USD could pull back toward trendline support at 1.5770, as traders judge that the ECB will leave rates steady going forward.

Equities – Xetra DAX Index

The Xetra DAX remains contained to a falling channel, helped by the index’s bounce from support at 6,000. The move is in line with the moves seen in global equity market indexes, but upcoming German economic data could weigh the DAX down on Friday. German producer price growth is anticipated to accelerate, raising the risks that the ECB will remain hawkish. However, if prices rise less than expected and market sentiment remains risk-seeking, the DAX could break above trendline resistance at 6,275 toward 6,400. Of course, traders should keep an eye on financial market news, as indications of distress amongst financial institutions could trigger widespread sell-offs in the global equity markets (and for that matter, forex carry trades).

Terri Belkas is a Currency Strategist at FXCM.