US Federal Reserve Board chair Janet Yellen. Photo: Gary Cameron/Reuters

Last week the EUR/USD’s seemingly-unstoppable six-week advance was interrupted by what the markets have dubbed as the ‘Yellen Effect’. After its six-week rally, that gave the euro over 3 per cent of gains when seen against the US dollar, last week we saw the currency pair give back -0.86 per cent, edging lower from recent 1.3966 highs just short of the psychological 1.40 levels. The euro bulls were interrupted just as the currency pair was marking fresh 2.5-year highs, and at a time when 1.40 was becoming increasingly more palpable.

What was this Yellen Effect? Last week Fed’s new chair Janet Yellen came out with a bang, as she addressed her first post-FOMC meeting and announced the Fed’s latest policy decision. In essence the announcements regarding Fed policy were not unexpected, but nevertheless investors chose to react quite strongly to the Fed’s communication.

From the Fed’s last policy announcement we saw that the pace of the Fed’s tapering continued as expected; the Fed announced another $10 billion reduction in its monthly asset purchases and is expected to terminate it by year-end. The most important changes that emerged from the last policy announcement were:

1) Stopped linking rate hikes to 6.5 per cent unemployment rate (adopted since December 2012).

2) Defined the “considerable time” between the end of the bond purchases and the first rate hike as six months (still, however, in line with the October 2012 policy statement that warranted exceptionally low levels for the Federal Funds rate at least until mid-2015).

The longer-term EUR/USD forecasts point towards the currency pair hitting 1.31 by end of 2014 and to breach 1.30 levels as we approach mid-2015 (when the first rate hikes are expected). Yet in the immediate term what we have seen till now is a surprisingly resistant euro – at the time of writing the EUR/USD is trading at 1.3808.

Early into the current week the euro reacted positively to stronger-than-expected French PMI data, showing that in March the manufacturing and services sector made it into growth territory, surpassing the 50 level. However, the euphoria was short-lived and eased by the time Germany and the EZ (as a whole) reported numbers that were softer compared to the previous, but nevertheless still at a safe level above the 50 that delineates growth from contraction.

These figures raise optimism because they suggest that the EZ economy continues in its recovery, but also because of the convergence between the EZ’s largest two economies – Germany and France. Monday’s figures saw the PMIs come closer as France picked up speed, while Germany eased slightly in a sign of convergence.

It was not only the euro’s resilience that left investors baffled; the Aussie was also a noteworthy rival among the major currencies. The Aussie surprised, given the recent weaker data out of China (early into Monday morning China’s HSBC PMI number continued to ease lower). The AUD usually tends to be affected by its close ties with Chinese trade.

The Aussie continues to garner further gains marking fresh three-month highs against the USD at 0.9157. The AUD is up +1.54 per cent in these last three months, according to the Bloomberg Correlation-Weighted Currency Index (BCWI).

This defiance of gravity by the Aussie may be because the softer Chinese data are actually feeding expectations of soon-to-be fresh stimulus for the Chinese economy.

UK Y/Y inflation eased to 1.7 per cent from a previous 1.9 per cent for February, easing to 4.5-year lows and slowing further from the BoE’s two per cent target. The British pound retains the title of the largest gainer among the major currencies for these past 12 months; according to the BCWI it is up +9.76 per cent at the time of writing. It seems that traders have already priced in most of the expectations for rate increases by the British Central Bank.

GBP/USD has eased to lows of 1.6465 for the current week, up to the time of writing. Despite the short-term, technical correction we have seen in these past three weeks, overall the trend has been bullish since July 2013 and we’ve seen the currency pair peak to 1.6822 (highs last seen in November 2009) in February this year.

The GBP has seen support even against the single currency; it reached one-year highs when EUR/GBP hit 0.8157 last February. Since then the price has seen some correction and we are currently trading at 0.8350.

Upcoming FX key events
Today: UK retail sales, US final annualised GDP and US personal consumption.
Tomorrow: UK final GDP, EZ consumer sentiment, German CPI & US Michigan consumer sentiment.

Technical key points
EUR/USD is bullish, target 1.4000, key reversal point 1.3700. EUR/GBP is neutral. USD/JPY is neutral. GBP/USD is bullish, target 1.6900, key reversal point 1.6250. USD/CHF is bearish, target 0.8575, key reversal point 0.9000. AUD/USD is neutral. NZD/USD is bullish, target 0.8675, key reversal point 0.8400.

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Rudolf Muscat is a senior trader at RTFX Ltd.