EUR Outlook: What to Expect from the ECB

Posted on

Daily FX Market Roundup 03-05-14

EUR Outlook: What to Expect from the ECB
USD: How Reliable are ADP and ISM in Predicting Payrolls?
GBP: No Changes Expected from BoE
CAD: Digging into the BoC Statement
AUD: Lifted by Stronger Growth and Service Activity
NZD: China Maintains 7.5% Growth Target for 2014
USD/JPY March Seasonality

EUR Outlook: What to Expect from the ECB

What is interesting about the euro’s recent price action is that the currency sold off when the tensions in Ukraine escalated but failed to rally when the fears began to ease. While concerns that the crisis is far from over can partially explain the euro’s underperformance, selling ahead of the European Central Bank rate decision is also putting pressure on the currency. There’s a war of words happening between the U.S. and Ukraine with Russia threatening to confiscate U.S. assets if sanctions are imposed. Talks have been held between U.S. Secretary of State Kerry and the Russian Foreign Minister Lavrov but the tit for tat means the situation could deteriorate quickly. Germany, the largest country in the Eurozone relies heavily on Russian oil and according to Philipp Missfelder, a member of the German government, sanctions on Russia would be damaging to Germany. This risk is certainly one that the central bank will take into serious consideration at tomorrow’s meeting.

For the most part, there haven’t been any major changes in the Eurozone economy since the February meeting and if the ECB didn’t feel that it was necessary to increase stimulus last month, they won’t find a reason to do so this month. Back in February, Draghi did not express any renewed concerns about the economic outlook or low inflation and at the time, this steady stance drove the euro up one full cent. As shown in the table below, since then, consumer spending rebounded and confidence increased. German unemployment rolls dropped by a smaller amount but the unemployment rate for the Eurozone remained unchanged. Service sector activity accelerated but manufacturing activity slowed. Inflationary conditions seem to have improved with core consumer prices in the Eurozone rising slightly last month. On balance, there was slightly more improvement than deterioration but the edge is extremely small. For this reason, not only do we expect no changes in monetary policy but also ECB President Draghi’s press conference should sound virtually identical to the previous month. The ECB still maintains a bias to ease and will remind us that they stand ready to take additional action if needed but given the recent pressure on the currency, that could sufficiently trigger a relief rally. Of course, there’s always a downside risk – the euro would sell off if the ECB increases its level of dovishness but based on the following data, they have little reason to do so.

USD: How Reliable are ADP and ISM in Predicting Payrolls?

With tensions between Ukraine and Russia easing further this morning, investors have been able to turn their focus to Friday’s non-farm payrolls report. After 2 months of subpar payroll growth, the Federal Reserve desperately needs a strong month of job growth to justify continuing their current pace of tapering. Unfortunately based on other labor market indicators released this morning, there’s a reasonable chance that job growth will fall short of expectations for the third month in a row. But the main question to ask is how reliable are the ADP and non-manufacturing ISM reports in predicting payrolls. According to ADP, U.S. companies added only 139k jobs in the month of February down from a revised 127k. ADP has always struggled to match NFPs and the fact that the number was revised down to 127k from an initial estimate of 175k in January shows how unreliable the report can be. As shown in the chart below, over the past 7 months, ADP overestimated private payrolls 6 times but if you widen the sample to over the past year, it only overestimated it 7 out of the past 12 months or 58% of the time. In other words, ADP can just as easily overstate as understate payroll growth but on average it misses the mark by 50k.

Since the U.S. is a service-based economy, traditionally the employment component of the non-manufacturing ISM report is the market’s favorite leading indicator for non-farm payrolls. This month, not only did the service sector expand at its slowest pace since February 2010 but the employment component of the report dropped to its lowest level since March 2010. This was also the first time that jobs contracted in over 2 years. However the last time the employment component was this weak, non-farm payroll growth was relatively strong – payrolls rose 156k in March 2010 after falling 50k the previous month. In November 2011, when the employment component of ISM services last contracted, non-farm payrolls rose 164k. As shown in the chart below, over the past 8 months, the directional change in the employment component accurately forecasted the directional change in payrolls 75% of the time. However if we expand the sample to 12 months, the accuracy rate drops to 58%. On an even longer sample set, non-manufacturing ISM is still a reliable guide for payrolls. Yet while we continue to believe that payrolls could fall short of expectations this Friday, it is important to realize that the leading indicators for NFPs can miss the mark as well. The Federal Reserve is certainly hoping that this will be case, as they want to continue tapering asset purchases at their current pace.

GBP: No Changes Expected from BoE

Better than expected U.K. economic data helped to drive sterling higher against the U.S. dollar and euro. The PMI services index declined last month but the deterioration was not as severe as economists anticipated. The index was expected to fall to 58 from 58.3 but instead dropped to 58.2. Taking a look at the PMI manufacturing and construction reports released earlier this week, there hasn’t been much change in the U.K. economy since January. All three PMI indices remain well above 50, which is indicative of continued expansion. As our colleague Boris Schlossberg pointed out “The PMI data suggests that UK economy is set to grow at 0.7% q/q rate in Q1 this year as it remains one of the best performing economies in the G-10 universe.” A generally healthy economic outlook will give the Bank of England confidence to leave monetary policy unchanged tomorrow. Unlike the ECB who holds a press conference regardless of whether changes are made, the BoE keeps their lips sealed until the minutes from the meeting are released. Therefore tomorrow’s rate announcement should be a nonevent for sterling.

CAD: Digging into the BoC Statement

The Canadian dollar traded higher against the greenback today despite a slightly more dovish statement from the Bank of Canada. As expected the BoC left interest rates unchanged. They acknowledged that growth towards the end of last year was slightly stronger than anticipated but warned that Q1 growth is likely to soften. Despite some signs of improvement, the Canadian central bank is worried about the underperformance of exports and business investment. They also feel that the downside risks to inflation remain important. In other words, the BoC is still worried about the outlook for the economy. Yet the Canadian dollar took the news in stride because investors were focused on selling U.S. dollars after the disappointing ISM report. The Australian and New Zealand dollars on the other hand performed well thanks to healthier economic data from Australia. Not only did GDP growth accelerate to 0.8% in the fourth quarter from 0.6%, but the PMI services index soared to 55.2 from 49.3. The Chinese government also maintained its official growth target of 7.5% for 2014. Premier Li promised a number of changes in banking and finance that would make the economy more efficient and productive. Their goal is make domestic demand “the main engine driving growth” by raising incomes and encouraging more service industries.

USD/JPY March Seasonality

Thanks in part to the sharp rally in the Nikkei, the Japanese Yen traded lower against all of the major currencies today. With no economic reports scheduled for release, we want to take this opportunity to discuss seasonality. March is the fiscal year end in Japan and there tends to be significant amounts of repatriation of foreign earnings during this time, as companies look to window dress their balance sheets. This leads many investors to believe that USD/JPY will have a downward bias this month. However taking a look at how USD/JPY has behaved in March between 2001 and 2013, we can see that seasonality has very little impact on the currency pair. In fact over the past 6 years, USD/JPY appreciated 5 times in March. Therefore while seasonality is interesting, it should not be blindly traded.

Kathy Lien
Managing Director

Leave a Reply

Your email address will not be published. Required fields are marked *