Euro Unwind Begins

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Market Drivers Mar. 11, 2016

Euro trades back 1.1100 as profit taking kicks in
UK Trade Balance in line
Nikkei 0.51% Dax 2.53%
Oil $38/bbl
Gold $1266/oz

Europe and Asia:
EUR GE CPI 0.4% vs. 0.4%
GBP UK Trade -3.4B vs. -3B

North America:
CAD Employment 8:30

After a wildly volatile day yesterday the currency market was much more subdued on the last trading day of the week as traders digested the massive moves caused by the ECB announcement.

After a night of consideration the markets decided that ECB policy actions announced yesterday would in fact be stimulative to the EZ economy and risk assets rallied with DAX up more than 2.5% and most of the Italian banking shares called limit up in Milan. The reaction in equities cause a profit taking selloff in in EUR/USD which dipped below the 1.1100 level in morning European dealing.

Mr, Draghi’s throw away comment at the ECB presser in which he suggested that negative rates have reached their downside limit, caused a massive short covering rally in the euro which spiked four big figures off its lows. The market however grossly overreacted as Mr. Draghi cleared meant that under current conditions no further move to negative rates would be necessary. Furthermore he clearly stated that the central bank would use all other tools as its disposal to help fight the deflationary forces in the region.

Mr. Draghi’s critics have noted that the ECB appears to be practicing fiscal stimulus under the guise of monetary policy and certainly the recent policy proposals to expand QE buying to the corporate bond market lend some credence to that claim. But the central bank is clearly frustrated with the anemic pace of growth in the region and the ever present danger of deflationary forces.

On the inflation front if oil stabilizes at these levels the base effects should begin to wear off as the year progresses and inflation readings will likely stabilize. On the other hand if commodity prices begin to slide down once again not will that be a sign of dampened global demand, but it will also keep the deflationary pressure alive in the EZ and the ECB may be forced to go further in its policy actions.

Meanwhile there appears to have been virulent opposition to Mr. Draghi’s latest moves from some members of the EZ with MNI reporting tonight that 4 members of the council voted against the agreement. The Germans are clearly worried about the impact of negative rates on their financial sector as 70% of the country’s savings rests with saving and cooperatives institutions which cannot pass on negative rates to their own members hurting their margins in the process.

With no US data on the docket today, FX flows will likely be driven by macro factors with currencies taking their cue from equities and oil. If risk assets continue to rally the unwind in the euro could persist and the pair could tumble all the way to 1.1000 level as the volatility seesaw continues. Ultimately however the pair remains under fundamental pressure and if at next week’s FOMC meeting the Fed hints that it may resume it tightening cycle the downward move in EUR/USD will resume in earnest.

Boris Schlossberg
Managing Director

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