Euro Extends Pullback

After rising to its best level since October 20, the euro reversed direction yesterday and has extended its pullback today. The unexpected tick up in US core CPI and better than expected retail sales may have helped spur the euro losses after a three cent run-up over the past several sessions. There bearish candlestick (shooting star) leaves the late euro longs in weak hands. However, the single currency remains above the down trendline drawn off the year’s high, recorded two months ago, that was violated earlier in the week. It comes in today near $1.1735. That area is likely to prove important in the near-term. It corresponds to the five-day moving average (~$1.1740), which the euro has not closed below since November 8 and is near the 38.2% retracement of the recent gains (~$1.1745).  

Fresh fundamental developments are light.  We do note that the self-imposed deadline of the end of the week to work out the new German coalition is approaching, and reports suggest that large gaps remain as the four-party talks continue. The Green Party has a special conference scheduled for November 25 to ostensibly vote on the terms. That said, the prospects that hammering out a coalition on a national level between such disparate parties as the Greens and the FDP is too much even for one with Merkel’s political acumen.   

If larger coalition talks fail, some suspect that Merkel might be able to entice the SPD, the current coalition partner back into the fold, but this looks like a stretch. The alternatives, though, are stark:an unprecedented minority government or new elections.    

However, as interesting as German politics may be, the driver of the euro may be more economic than political. On a purely directional basis, the correlation between the US-German two-year differential and the euro exchange rate is as tight as it has been all year,with a correlation of 0.85 over the past 60 sessions.After dipping yesterday, the premium is back above 240 bp today.