EUR – #1 Factor Behind Post ECB Rally, Next Levels

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Daily FX Market Roundup 04-02-13

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management

EUR – #1 Factor Behind Post ECB Rally, Next Levels
USD: Counting Down to Non-Farm Payrolls
USD/JPY – Aiming for 100
GBP – Lifted by Stronger PMI Services
CAD – Employment, Trade and IVEY
AUD – Shrugs off Stronger PMI, Retail Sales
NZD – Oil down another 1%

EUR – #1 Factor Behind Post ECB Rally, Next Levels

When ECB President Mario Draghi initially spoke this morning, his cautionary comments about the outlook for the Eurozone economy drove the EUR/USD to a 4 month low of 1.2746. However during the Q&A session, the EUR/USD began to recover and ended the day up approximately 0.7%. While Draghi sounded more pessimistic than optimistic, saying there are downside risks in the second half, he also admitted that his hands are tied and the ECB’s options are limited. Instead of giving any hints about the possibility for more easing outside of saying the discussions were “extensive” and the ECB stands ready to act if needed, he spent more time talking about what they have done so far and how it has benefitted the economy and stabilized the financial markets. He avoided giving a direct answer on additional easing and investors interpreted this to mean that a rate cut won’t come easy. Draghi also argued that other players need to get involved which suggested that he is relying on other governments and public agencies such as the European Investment Bank to provide additional stimulus by reviving SME financing.

The EUR/USD had been sold aggressively going into the monetary policy announcement on the hope that the ECB will ease or at least lay the foundation for increasing stimulus. Unfortunately Draghi failed to set the market up for a rate cut and as a result, shorts were squeezed in. Draghi also said the problems in Cyprus reinforced the central bank’s determination to support the currency and while Cyprus is “no template” for a future bailout, these comments suggest that the ECB will be involved quickly if another country were to face the same problems.

Can this EUR/USD recovery be sustained? On a technical basis, the breakout in the EUR/USD opens the door for a move to the currency pair’s next resistance level of 1.30. A move to the 100-day SMA at 1.3150 is also possible but we are skeptical of the sustainability of this rally as another rate cut is still on the table. While the European Central Bank and the Federal Reserve are both currently engaged in aggressive monetary easing, the ECB is debating the need to increase stimulus whereas the Fed is considering tapering asset purchases. This divergence in monetary policy plans should play a key role in the outlook for the EUR/USD. We believe the main takeaway from Draghi’s comments today is that they haven’t shut the door on additional easing. The ECB’s concerns center on weak consumption and failed structural reforms and while Eurozone growth should benefit from a recovery in global demand, so far export demand is weak. We believe that the downside risks for the Eurozone are realistic and likely to increase in the coming months especially if there is a correction in global equities.

USD: Counting Down to Non-Farm Payrolls

U.S. non-farm payrolls are scheduled for release tomorrow and the sustainability of today’s rally in EUR/USD and USD/JPY will hinge on the outcome of this key report. Economists are currently looking for job growth to increase by 190k in the month of March, down from 236k in February. Based on other labor market reports, the odds certainly favor weaker numbers. This morning, Challenger Grey & Christmas reported a 30% increase in layoffs in March and jobless claims jumped to 385k – though weekly claims were distorted by weather problems and the Easter holiday. Nonetheless, private payroll provider ADP said U.S. companies added only 158K jobs last month, down from an upwardly revised 237K and the employment component of non-manufacturing ISM dropped to a 4 month low of 53.3 from 57.2. Consumer confidence also declined last month and all of these reports are consistent with slower job growth. The only wrinkle was jobless claims – today’s number may have been bad but the 4 week moving average is still lower in March than February. If non-farm payrolls grow by 175K or less, USD/JPY could give slip more than 0.5%. The EUR/USD will rally initially in this case but whether the rally lasts will depend on how bad the number is and its implications for risk. Stronger payrolls on the other hand will fuel an additional rally in USD/JPY that should take the pair up to its March high of 96.70.

USD/JPY – Aiming for 100

The biggest moves in the FX market today were in the Japanese Yen crosses with USD/JPY up more than 3.5% as the Bank of Japan’s easing measures last night satisfied investors. The BoJ expanded its JGB purchases to 40 year bonds which means that all JGB maturities are eligible for purchase. They also increased their target purchases to an annual pace of JPY60-70 trillion, translating to about Y7 trillion a month, up from a prior level of Y3.7 trillion. This near doubling of monthly asset purchases represented bold action from the central bank. As expected, the BoJ merged its APP program with Rinban operations and abolished the banknote rule. With this comprehensively aggressive easing, the correction in USD/JPY is over. The currency pair is now trading above 95 and should be on its way 100. Today’s moves signal that the BOJ is extremely serious about reaching its 2% inflation goal over the next two years and BoJ Governor Kuroda even hoped to achieve it sooner. Therefore even an abysmal non-farm payrolls report may not pose a lasting threat to the renewed uptrend in USD/JPY.

GBP – Lifted by Stronger PMI Services

The British pound strengthened against the U.S. dollar today following better than expected service sector data. PMI services increased to 52.4 from 51.8 in the month of March, rounding out a set of PMI reports that have all signaled improvement in economic activity. Earlier this week we learned that construction activity improved with the contraction moderating and while manufacturing activity fell short of expectations, it was still stronger than the previous month. The U.K. economy may not be performing as poorly as some economists may fear and the hope that this is true was enough to drive sterling higher. As expected the Bank of England left monetary policy unchanged. We still believe that when the minutes are released, there will be continued caution within the central bank but with the currency still trading near a 3 year low, the upside pressure on inflation will remain a concern. Halifax house prices is the only piece of U.K. data on the calendar tomorrow. The main driver of GBP flows will be the U.S. non-farm payrolls report.

CAD – Employment, Trade and IVEY

It was a mixed day for commodity currencies as the Canadian and New Zealand dollars strengthened but the Australian dollar weakened. Tomorrow will be a busy one for the CAD with trade, employment and manufacturing sector reports scheduled for released. Typically these are spaced out better but the Easter Holiday shifted the release date of some reports. The CAD hit a 1 month high in anticipation and could pare its gains if the data surprises to the downside. Of these 3 releases, the employment numbers should be the most market moving. After adding 50k jobs last month, a far more modest 6.5k increase is expected. It is important to remember that Canadian employment will be released at the same time as U.S. non-farm payrolls and USD/CAD will react based on the larger surprise. Weak U.S. job growth has traditionally been negative for the CAD while stronger U.S. growth is positive because of Canada’s reliance on the U.S. economy. The AUD on the other hand had initially rallied on the back of stronger data (service sector activity, retail sales and building approvals all surprised to the upside) but gave up its gains after the BoJ announcement.

Kathy Lien
Managing Director

2 thoughts on “EUR – #1 Factor Behind Post ECB Rally, Next Levels”

  1. If the ECB cuts interest rates it would feed through into the well capitalised banks in the core where arguably interest rates are too low already. A rate cut would do little to benefit the periphery where the monetary transmission mechanism is blocked. So a rate cut would just exacerbate current imbalances without addressing the problem of low growth in the periphery. It would also needlessly use up some of the ECB’s amo which could be saved for a rainier day…

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