On a day when the European Central Bank (ECB) is due to release its monetary policy statement and to answer questions from press representatives, an interesting correlation may be more important for the EURUSD than what the ECB will actually signal.
The central bank is expected to keep the interest rates unchanged, but that does not mean that the Euro will not travel.
There is a strong correlation between the Dollar Index (DXY) and the SOMA purchases minus the Treasury issuance. Recently, the latter declined dramatically, poised by being followed by the DXY.
Defining the Elements
Before defining the elements in this correlation, we must pay attention to the fact that the DXY is represented on the chart on a reversed scale. Effectively, it means that it is inversely correlated with the SOMA purchases net of Treasury issuances. Hence, when purchases net of issuances fell, the DXY rises – EURUSD bulls, suddenly, have a problem on a medium-term perspective, because over 50% of the DXY composition is the Euro.
SOMA is the acronym for the System Open Market Account used by the Fed to increase or decrease the securities in the system. As the chart shows, net of Treasury issuance, the USD liquidity in the system declined dramatically in the last weeks, suggesting a higher USD in the near term, because it leads the reversed DXY by around sixty days.
The EURUSD broke higher in May from the 1.08 area and reached just above 1.14 one day after the June 2020 ECB meeting. Since then, in the last six weeks (less than sixty days), it barely corrected 23.6% of the entire move, and yesterday it made a new high at 1.1452. In other words, for the past six weeks, the EURUSD traded with a bid tone, investors pouring in on every single dip.
However, if the correlation presented here stands true, as they did for the last couple of years, the DXY and, implicitly, the EURUSD, are due for at least a more severe correction, if not a sharp reversal. As the USD liquidity impulse is turning extremely negative, it is difficult to see a much higher EURUSD, especially considering the fact that the ECB is expected to be on stand this week.
The game-changer may come from the EU negotiations over the recovery fund, due this coming Friday and Saturday. If market participants sniff a bluff from the Northern states, the EURUSD reaction may exceed many traders’ expectations.