Next Stop for Euro is 1.10

While the European Central Bank left monetary policy unchanged today investors sold euros aggressively after the central bank sent a strong message to the market that they are not only ready and willing to increase stimulus but actively exploring ways to do so. Going into the meeting we outlined 4 ways the ECB could crush the euro (see below) and today, Mario Draghi specifically mentioned each of these as possible options including the boldest move of lowering the deposit beyond its current level of minus 0.2%.

1) Lower deposit rate

2) Extend the end date for QE purchases

3) Increase the size of the QE program

4) Broaden types of bonds purchased

The central bank is worried about lower inflation, weaker global demand and slow structural reforms. The ECB can support domestic demand through policy and lower oil prices are helping but their hands are tied when it comes to foreign demand. One of the few ways they can encourage external demand is by weakening the euro through easier monetary policy. In fact their outlook is so grim that some members wanted to increase stimulus today. However a decision to expand stimulus is politically more difficult for the ECB than any other central bank. Nonetheless by saying that the degree of policy accommodation must be examined in December, Super Mario is effectively telling us that he is ready and willing to don his Santa cap this winter. Expectations are now set for more easing.

EUR/USD is headed for a break of 1.10 because unfortunately the strength of today’s 2% decline indicates that investors were not positioned for dovishness. If they were, the currency pair would not have experienced the largest one-day drop in 2 months. Typically this type of strong move has at least 1 to 2 cent of continuation. 1.10 is very significant support in EUR/USD and we expect this level to be tested and breached for a possible drop to 1.08. Eurozone PMIs are scheduled for release tomorrow and chances are these reports will exacerbate selling by confirming the slowdown in the region’s economy.

The U.S. dollar traded very well today, rising sharply against all of the major currencies. Not only did the greenback benefit from the Fed’s hawkish policy stance but jobless claims continued to fall and existing home sales rose significantly more than expected. The four-week moving average of claims dropped to its lowest level in over 40 years. Although the U.S. non-farm payroll reports show job growth slowing, layoffs have been at historically low levels, which suggest that companies are just waiting for signs of stronger demand before stepping up hiring. The housing market also remains firm and collectively these 2 reports should ease the Fed’s worries about the economy. The dollar should remain firm as long as the Fed is still thinking about tightening at a time when other major central banks are thinking about easing.

The second best performing currency today was the New Zealand dollar. While no economic reports were released today, New Zealand is one of the few countries seeing a revival in growth. The recent increase in dairy prices has gone a long way in stabilizing the outlook for the economy. We’ve even seen consumer confidence and business activity tick up as a result. The RBNZ will be happy with the latest economic reports but if NZD rises any further, their concerns about a strong currency could return. Meanwhile the Australian dollar ended the day unchanged. Business confidence dropped in the third quarter, which is not surprising considering that Chinese growth slowed during this period.

USD/CAD pulled back slightly after yesterday’s strong gains. We are actually surprised that the currency pair did not decline further given the upside surprise in Canadian retail sales. Consumer spending increased 0.5% in the month of August after rising an upwardly revised 0.6% in the July. It has been a while since we have seen positive Canadian data and today’s report was a breath of fresh air. Oil prices also edged slightly higher but broad based demand for the greenback along with the Bank of Canada’s lowered GDP forecast kept the currency pair supported. Consumer prices are scheduled for release tomorrow and easier inflationary pressures could reinvigorate the rally in USD/CAD.

Sterling traded sharply higher versus the euro and only marginally lower versus the U.S. dollar. U.K. retail sales rose 4 times more than expected. Even though spending in August was revised lower, the upside surprise in September more than offset the prior month’s weakness. Sterling did not benefit much from the move but we believe that after today’s report, it is poised for stronger gains particularly versus euro and the commodity currencies. GBP/USD would look attractive between 1.5300 and 1.5350.