Will ECB Help or Hurt the Euro?

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Daily FX Market Roundup 04-02-14

Will ECB Help or Hurt the Euro?

Dollar Trickles Higher on Stronger ADP

GBP: Unfazed by Weaker Housing Data

NZD Hit Hard by Lower Milk Prices

AUD: Australian and Chinese PMI Services

CAD: Trade Balance Expected to Return to Surplus

USD/JPY Supported by US Yields and Nikkei

Will ECB Help or Hurt the Euro?

Buckle your seat belts because in the next 48 hours, there will be even more volatility in the foreign exchange market. Not only do we have important data from Australia and China, the U.S. releases its non-manufacturing ISM report and European Central Bank delivers its monthly monetary policy decision on Thursday followed by non-farm payrolls on Friday. The last time the ECB changed monetary policy was back in November and since then, they kept interest rates steady. No changes are expected this month but even when the central bank maintains its current policy, the EUR/USD will move based on the ECB’s bias and their outlook for inflation and growth. Over the past 5 months, the EUR/USD appreciated on the day of the ECB meeting on 4 occasions with the one outlier being the month that the ECB surprised with a rate cut. This indicates that the central bank is not as dovish as investors anticipated. Whether the ECB rate decision will help or hurt the euro this month depends on the level of pessimism from Mario Draghi.

Based on the following table illustrating how the Eurozone economy changed since the March meeting, there has clearly been more deterioration than improvement in activity. The slowdown in the manufacturing and service sectors led to a decline in business and investor confidence. Inflationary pressures also eased, leaving the central bank with plenty of reason to keep monetary policy easy. There were some bright spots this week – namely a downward revision to the unemployment rate and a surprise increase in retail sales. While consumer spending grew at a slower pace in February, economists had been looking for a 0.5% decline. However these recent improvements may not be enough to ease Mario Draghi’s concerns. We don’t expect any fresh optimism from the ECB President and instead are worried that the pressure is building for additional action. Last month a number of policymakers talked about the possibility of negative rates and Draghi did not join the discussion then, but there’s a reasonable chance that come tomorrow he will say the option is on the table. So while the euro responded positively to the last 4 monetary policy decisions, the recent deterioration in data leads us to believe that Draghi’s comments will drive the euro lower and not higher.

Dollar Trickles Higher on Stronger ADP

The U.S. dollar traded higher or held steady against all of the major currencies. With less than 48 hours to go before the non-farm payrolls report, investors are buying dollars slowly in the hopes that Friday’s jobs number will be strong. According to private payroll provider ADP, U.S. companies added 191k jobs in the month of March. While this was less than economists expected (the forecast was 195k), the miss was small and job growth the previous month was revised sharply higher to 178k from 139k. Based on this release, the labor market continued to improve in the month of March, which will help payrolls meet its targeted increase of 200k. There is one more key labor market report scheduled for release before payrolls and that is the non-manufacturing ISM index. Historically changes in the employment component of service sector ISM can have a strong correlation with non-farm payrolls but it is far from perfect because it failed to accurately predict the pickup in job growth last month. Nonetheless, it is a report that investors watch closely and respond to so if service sector activity improves, it could be just what USD/JPY needs to break above 104. Fed Presidents Bullard and Lockhart also spoke this morning and while neither gentleman are voting members of the FOMC this year their views couldn’t be any more different. Bullard expects interest rates to rise in the first quarter of 2015 while Lockhart expects the first rate hike in the second half of that year.

GBP: Unfazed by Weaker Housing Data

The British pound ended the day unchanged against the dollar and slightly higher versus the euro. Softer housing market data did very little damage to sterling. According to Nationwide, house prices rose 0.4% in the month of March. Although the pace growth was less than expected and slower than the previous month, prices in London rose for the 15th consecutive month. Prices in the city and the rest of the country are widening at an alarmingly rapid rate, making it more difficult for the Bank of England to manage monetary policy. The average price of a home sold in London is now 100% more than elsewhere in Britain. The Construction sector PMI index also fell to a 3 month low of 62.5 but any reading above 60 represents solid growth. These reports had very little impact on sterling as traders wait for the more important service sector PMI index. If activity slows in this sector as well, then growth has peaked which will make it very difficult for GBP/USD to hold above 1.66.

NZD Hit Hard by Lower Milk Prices

The worst performing currency today was the New Zealand dollar. There was no scheduled data from New Zealand but dairy prices plunged 8.9% at this morning’s Fonterra Cooperative Group’s online auction. Over the past 2 months, dairy prices have fallen 18% after farmers increased production in response to higher prices. A local economist could not have phrased it better “The fact that about 30 per cent of our merchandise export goods has fallen 18 per cent over the last two months is clearly negative for export returns, even if it takes a while to show through in the data.” The decline in dairy prices is so severe that some people are even saying that the RBNZ could slow rate hikes in response. It is far too early to say but this is certainly a risk that we are monitoring. The Australian and Canadian dollars on the other hand ended the day unchanged. Tonight is a busy one for AUD with retail sales, PMI services and Chinese non-manufacturing reports scheduled for release. AUD has been hovering near its 4 month highs and for the rally to be sustained we need some positive Australian or Chinese data. Trade numbers are expected from Canada and given the rise in the IVEY PMI index in the month of February, the deficit is expected to return to surplus.

USD/JPY Supported by US Yields and Nikkei

There was very little consistency in the performance of the yen today, which traded lower versus the British pound, U.S., Canadian and Australian dollars and higher versus the euro, Swiss Franc and New Zealand dollar. The 1% rally in the Nikkei overnight and 5bp increase in U.S. yields provided support to USD/JPY. No major Japanese data was released and according to a new BoJ Inflation Outlook of Enterprises survey, all firms in Japan expect inflation to hit 1.7% in 3 to 5 years time, which is below the central bank’s 2% target. These lower expectations will give the central bank the flexibility to ease monetary policy because inflation expectations do not exceed their target. The manufacturing PMI index is scheduled for release this evening. We expect activity to improve ahead of this month’s consumption tax increase.

Kathy Lien
Managing Director

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