Will the ECB Crush the Euro?

Tomorrow’s European Central Bank monetary policy announcement is the biggest event of the week and it could be even more market moving than Friday’s non-farm payrolls report. Over the past year, ECB rate decisions have not been kind to the euro. In the last 15 months, EUR/USD fell after every policy meeting except for September 2018. History could be repeated as the central bank is seriously considering a new targeted long term refinancing operation (TLTRO). This announcement could be made as quickly as Thursday because it is not a question of if but a matter of when the loan facility will be renewed. In January, the ECB took the unusual step of lowering their risk assessment at a meeting without updated staff forecasts. Those economic projections will be released on Thursday and should be lowered to support the central bank’s grim outlook. While there have been some improvements in the Eurozone’s economy since then (see table below), growth slowed sharply at the end of last year and prices continue to fall. At 1.5%, Eurozone CPI is running far below the central bank’s target.

Based on the growth and inflation outlook alone, the ECB needs to be dovish. However, the current TLTROs are due next June and when the maturity falls below a year, they are considered short term and subject to new regulations that will incentivize banks to pay back the loans sooner, therefore reducing the amount of cheap loans in the market. The ECB has already discussed a new TLTRO so the question is 4 fold:

1. When will they commit to new TLTRO
2. What will be the maturity
3. Will it have a fixed or floating interest rate
4. Will there be limits

The more clarity the ECB provides the greater impact on the euro. If they fail to commit to new loans this week even if it does not include details, we could see EUR/USD squeeze to 1.14 fairly quickly. If they say a new TLTRO is coming and details will be provided in April, the euro should fall and then stabilize quickly because they are meeting not exceeding bearish expectations. If they have the whole program hashed out and announce new loans with 3 to 4 year maturities, EUR/USD could test its November low of 1.1215.

The Canadian dollar dropped to its weakest level in 2 months after the Bank of Canada said there is increased uncertainty on the timing of future rate hikes. Business investment is lower, consumer spending and housing is soft and for all of these reasons, not only was the fourth quarter slowdown deeper than forecasted but Q1 growth should fall short of expectations as well. With inflation expected to remain below 2% throughout 2019, the Bank of Canada is basically telling us that no rate hikes are on the horizon. While this may not be a surprise to our readers, it was just the excuse that loonie traders needed to send the currency lower. Data released alongside the rate decision supported the slide. The fall in oil prices drove Canada’s trade deficit to its highest level ever at the end of last year and conditions do not appear to have improved with the IVEY PMI index falling to its lowest level since May 2016. Canadian labor data is scheduled for release on Friday and a weaker reading is expected after last month’s sharp rise. Having broke above all major moving averages, the next stop for USD/CAD should be 1.35.

The Australian and New Zealand dollars also fell sharply on the back of weaker than expected Australian Q4 GDP numbers. The economy expanded by only 0.2% in the last 3 months of the year and this slowdown pushed the annualized pace of growth down to 2.3% from 2.7%. We don’t expect a relief rally from tonight’s Australian retail sales and trade balance. Between the 2 reports, retail sales will be the most important and the sales component of PMI services fell sharply in January and December, signaling a slowdown in spending.

Meanwhile the biggest trade deficit since 2008 and a smaller increase in ADP prevented USD/JPY from recapturing 112. The pair has been hovering below this level for the past few days and a sustainable breakout in one direction or another will have to wait for NFP. The Beige book report had very little impact on the dollar – 10 out of 12 districts reported slight to moderate growth and half of the regions said the government shutdown slowed activity. Some districts saw upward price pressure from tariffs and a tight labor market with notable worker shortages. These are mostly positive reports but the dollar shrugged off the news.