Will Euro Break 1.10?

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Daily FX Market Roundup 09.22.15

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

Will Euro Break 1.10?

For the next 24 hours, the focus of the foreign exchange market will be on the euro but before discussing why, it is important to talk about today’s sharp sell-off in equities and currencies. U.S. stocks closed down more than 1.0% and the deterioration in risk appetite was driven by a number of factors. Most importantly, concerns about the impact of Fed tightening have returned and if the doves (Lockhart and Yellen) are saying that rates could be increased as early as October, then there seriously could be a strong motivation within the central bank to raise rates in 2015. Their decision to delay this month could be just that – a one to three month wait for more confirmation. The widespread gains in the U.S. dollar confirm that rate hike expectations are a big driver of today’s move in currencies. However investors are also nervous about whether the Federal Reserve is making the best decision for the U.S. economy. According to the Richmond Fed index, manufacturing activity is contracting in the month of September. This follows similar slowdowns reported in the NY and Philadelphia regions. Chinese data is also scheduled for release this evening and there are legitimate concerns that tonight’s report could shine a light on the ongoing challenges in the world’s second largest economy. On Monday, Fed President Lockhart said the central bank’s focus is the domestic economy but as we have seen time and again the U.S. is not immune to global market troubles.

It has been a very challenging start of the week for euro and unfortunately trading in the single currency will only become messier as the week progresses. EUR/USD declined for the third straight day, closing in our 1.10 target level. Over the past month there has been an extremely consistent message coming out of the European Central Bank. Policymakers expressed their unified frustration with the region’s fragile recovery, low level of inflation and global market uncertainty. The primary focus this week will Mario Draghi’s hearing in Brussels tomorrow. This is a quarterly grilling by the European Parliament’s Committee of Economic and Monetary Affairs. If the head of the European Central Bank confirms that they could boost the Quantitative Easing program, EUR/USD could drop to 1.10. Even with the latest decline in the euro, the currency is 3 cents higher than where it was in July and the price of crude is 10% lower. While the euro has fallen sharply, it is still up nearly 3 cents from its July lows and with today’s decrease, the price of crude is more than 10% lower than 2 months ago, giving the ECB more reasons to be cautious than optimistic.

Eurozone PMIs numbers are also scheduled for release and investors are waiting for weaker data to confirm their bearish outlook. Given the concerns of European policymakers and the sharp decline in the outlook component of the ZEW survey, we believe the risk is to the downside for these reports. Technically the level at which the EUR/USD rally failed last week is a significant one. 1.1466 capped gains in the currency pair back in May and again in June and has now marked the top for the currency pair.

The worst performing currency today was the British pound, which fell sharply on the back of weaker public sector finances. Pubic borrowing hit 12.1 billion in the month of August, the highest level in 3 years. Economists had been looking for improvement but lower tax receipts and higher government spending. This report highlights the challenges that Chancellor Osborne faces in meeting his deficit reduction targets. Manufacturing activity is also slowing according to the last survey from the Confederation of British Industry. The CBI index dropped at its fastest rate in 2 years. Economists had been looking for the Total Trends index to rise to 0 from -1 but instead it dropped to -7. According to the director of the CBI, “Exports are the missing link in the UK recovery at the moment, with the strong pound squeezing manufacturers’ margin.” Support in GBP/USD is at 1.5330.

The Australian dollar was the day’s second worst performer. Although consumer confidence increased and house prices rose more than expected, Aussie was hit hard by the decline in copper and gold prices. The rising dollar and worries about demand from China drove copper prices to a 3-week low. Tonight’s Caixin Chinese manufacturing PMI index will determine whether the commodity currencies will see further losses. If manufacturing activity slows, AUD/USD could drop below 70 cents and NZD/USD could test 62 cents.

The Canadian dollar continues to trade lower ahead of Wednesday’s retail sales report. Economists are looking for the improvement in the labor market to drive stronger spending but stagnant wholesale sales growth raises the risk of a downside surprise. The gains in the U.S. dollar also drove oil prices lower, adding pressure on the loonie. In addition to retail sales, we have oil inventory data due tomorrow.

Japanese markets were closed on Tuesday but that did not stop the Yen from trading higher against all of the major currencies including the U.S. dollar. The losses in USD/JPY confirm that the primary theme of today’s trade was risk aversion. However the strength of the Yen will only make life more difficult in Japan. With the stimulative impact of Abenomics beginning to fade, the recovery is slowing. Tonight’s PMI manufacturing index is expected to show a slowdown in manufacturing activity while thursday’s consumer price report could show core inflation turning negative for the first time in 2.5 years. Combine that with the recent downgrade by S&P and we can see the Yen losing its luster.

Kathy Lien
Managing Director

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