What Are The Markets Facing?

Eurostat estimates for Euro-zone CPI are expected to show at 5:00 EDT that inflation accelerated at an even faster clip of 4.1 percent in July. If CPI is indeed confirmed at this pace, the figure would mark the highest level in more than 16-years and would be extremely bullish for the euro, especially since European Central Bank President Jean-Claude Trichet remains hawkish even after the Bank’s 25bp hike to 4.25 percent early this month. However, a weaker-than-expected reading could lead the euro to sell-off sharply, as European politicians – and the constituents voting them into office – are becoming increasingly unhappy with the ECB’s choices. Indeed, economic conditions are deteriorating quickly throughout the Euro-zone, as the PMI surveys for both the manufacturing and services sectors fell below 50 in June, which signals a contraction in business activity. As a result, a slowing in CPI growth will likely lead for calls by these officials for the ECB to consider cutting rates, and while this won’t be entirely effective given the central bank’s “independent” status, it should prevent Mr. Trichet from raising rates further.

Bonds – 10-Year German Bund Futures

Bund futures have recovered quite a bit from the June recent lows of 109.75, as market-wide risk aversion leads government debt higher. Looking ahead to Thursday, Euro-zone CPI estimates for July are expected to show yet another rise, which could weigh Bunds back below 111.00 as the markets bet that the European Central Bank will remain hawkish. However, if traders continue to flee risky assets in favor of save havens like government bonds, Bunds could continue to climb to target trendline resistance at 112.00.

FX – EUR/USD

From a long-term perspective, EUR/USD continues to trade within a wide range of 1.5365 – 1.6000, as the US dollar consolidates across the majors. Since we’ve already had a test of 1.60 and a break below the 100 SMA at 1.5665, the next logical move is toward the multi-month lows at 1.5365. However, a break below near-term support at 1.5580 will be required first. Looking ahead to Thursday, Euro-zone CPI is expected to rise 4.1 percent in June from a year earlier, which could lead EUR/USD higher. Indeed, this data is especially important ahead since ECB President Jean-Claude Trichet remains stubbornly hawkish even after his July rate hike to 4.25 percent. However, lower than expected CPI figures would shift the market’s focus to the Euro-zone’s clear economic slowdown and may lessen speculation of another rate increase, which would lead the pair to tumble toward the 1.5365 support level.

Equities – Xetra DAX Index

Despite the strong bounce from support at 6,000, the Xetra DAX remains within a downtrend. The moves in the index have been in line with the moves seen in global equity markets, but upcoming Euro-zone economic data could weigh the DAX down on Thursday. The estimate for Euro-zone CPI in July is expected to rise to 4.1 percent from 4.0 percent, 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 rally toward trendline resistance at 6,500. 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.