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Global Macro: Deflation Fears Hurt Euro

NEW YORK (TheStreet) -- The CurrencyShares Euro Trust (FXE) could come under pressure this week as European deflation fears prompt investors to favor the U.S. dollar.

The European consumer price index released Tuesday showed a 0.7% increase in core inflation in December, well below the European Central Bank's 2% target. The data come on the heels of strong manufacturing and services sector numbers. That raises the question about why prices aren't also increasing.

If strong manufacturing data translate to growth, then the next logical step would be for prices to move higher. The ECB will meet on Thursday to discuss policy, and deflation will almost certainly be one of the talking points

The central bank may not implement new stimulus measures at the meeting, but it will probably attempt to talk down fears. Still, the U.S. dollar is likely to strengthen versus the euro, especially if fears about deflation in Europe persist.

Meanwhile, U.S. trade data, released Tuesday, showed that the country's trade deficit was shrinking. Lower oil prices in recent months led to cheaper import prices, and stronger domestic output caused exports to accelerate.

The U.S. trade deficit is factored into the country's gross domestic product measurement. When exports grow faster than imports do, then the deficit narrows, which is bullish for growth. The improvement in the trade data caused analysts to raise their projections for first-quarter growth.

Stronger growth is positive for the dollar, and so is tighter monetary policy. Minutes from the Federal Reserve's meeting in December will be released today, and should show that policymakers want to reduce stimulus while keeping short-term rates low.

This news should strengthen the dollar against the euro, especially in a time where the ECB is expected to release dovish comments the following day.

The chart below of the euro/dollar currency exchange-traded fund shows a potential double-top pattern forming. If monetary policy in Europe and the U.S. continues to trend in opposite directions, then the euro could start to decline.

Continue to watch the movement of inflation numbers in the Europe and the U.S. to get an idea of where central bank policy will go in the future.

FXE ChartFXE data by YCharts

At the time of publication, the author had no position in the fund mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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