expectations are starting to increase

The EUR/USD continues to see risk sentiment have the greatest influence on price action as movement in the DJIA is explaining 41% of overall direction. However, U.S. interest rate expectations are starting to increase in importance as they have become a weighing factor with a -0.24 correlation. Many expect that the Fed will start tightening sometime next year and as we get closer to that possibility traders may begin to hedge their bets developing bullish dollar sentiment. Meanwhile, the ECB has clearly signaled that it will also wait until 2010 before considering tightening which has made yield expectations for the region a non-factor in recent price action.
Overnight index swaps are pricing in 87 bps of rate hikes for the ECB over the next twelve months which is near the highest levels since June, 2008. That is when we saw surging oil prices push inflation to uncomfortable levels. Currently we are not seeing consumer prices anywhere near those levels. In fact today’s Euro-Zone CPI-estimate unexpectedly fell to -0.3% from -0.2% which is well below the central bank’s 2% target. Therefore, policy makers will remain reluctant to initiate a tightening policy unless there is a viable threat of inflation. Until then we may see interest rate expectations have little impact on overall price action for the Euro. The producer price report for August is due out on Friday and is expected to show a 0.4% gain. If businesses are able to pass on their increasing costs to consumers than we may start to see the outlook for monetary policy change and grow in importance.