Is QE Just A Way to Drive EUR/USD Lower?

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Market Drivers January 23, 2015

Fresh multi-year lows as EURUSD drops to 1.1219
UK Retail Sales beat
Nikkei 1.05% Europe 1.47%
Oil $46/bbl
Gold $1294/oz.

Europe and Asia:
CNY HSBC PMI 49.8 vs. 49.5
EZ PMI Svc 52.3 vs. 52.1
EZ PMI Man 51 vs. 51
UK Retail Sales 0.4% vs. 0.6%

North America:
CAD Retail Sales 8:30
USD New Home Sales 10:00

The EUR/USD tumbled to fresh multi year lows today breaking the 1.1300 barrier before finally finding a modicum of support just ahead of the 1.1200 figure as one way price action continued in the pair in the wake of yesterday’s QE announcement by the ECB.

Sentiment towards the euro remained strongly negative with traders tripping stops in early European dealing as markets showed little faith in Mr. Draghi’s plan to revive demand in the region. The ECB QE program scheduled to be approximately 60 Billion Euros per month was at the lower end of the market estimates and its doubtful that the hodgepodge arrangement that shuns risk sharing by putting most of the onus on the individual member central banks will create the positive credit conditions to spur investment and demand.

As many analysts have pointed out QE works best in crisis conditions and by waiting a full seven years to initiate its first policy move the ECB may be guilty of doing too little too late. However, perhaps the European monetary authorities fully realize the limitation of their method and perhaps they are actually aiming for a different goal.

Today’s comments by ECB Executive Board member Bernard Coeure provide a clue to ECB’s true intentions. Speaking on CNBC Mr. Coeure stated that the exchange rate was the true transmission mechanism of QE. Taken from that perspective the ECBs actions make perfect sense. The QE announcement has shaved another 300 points off the EUR/USD exchange rate and the pair is now fully 20% lower than just nine months ago. Such a massive decline in rates is likely to prove to be a huge cost reduction for the export driven EZ economy and the concomitant decline in oil prices has essentially offset any inflationary pressures that a devaluation may bring.

Indeed an inkling of improvement can already been seen in the latest flash PMI data out of the region with French manufacturing PMI rising to 49.5 from 48.1 the month prior. If France and then Italy could see their PMI numbers climb above the 50 level over the next few months that would be proof positive that the ECB QE plan is working – but perhaps not in the way that the market initially thought. In any case the downwards pressure on the EUR/USD is likely to remain for quite some time and any rally in the pair with be a good opportunity to reload the shorts as the 1.1100 level beckons. For the longest time the EUR/USD was woefully overvalued on purchasing power parity basis, but such corrections in the forex market rarely stop at fair value most often slipping to the other end of the extreme, which is why the selling in the pair after a requisite bounce is likely to continue.

Boris Schlossberg
Managing Director

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