4 Reasons Why Euro Soared Post ECB

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

The euro soared on Thursday breaking above 1.20 and hitting a high of 1.2060 following the European Central Bank’s monetary policy announcement. To some this move may seen confusing because the ECB did not reduce asset purchases but Mario Draghi promised that changes to their Quantitative Easing program are coming. The head of the central bank said explicitly that the “bulk of QE decisions will probably be taken in October.” Back in July, he indicated changes will be made in the fall and investors interpreted this to mean today’s meeting because it coincides with staff forecast updates. However as Draghi indicated Thursday, the decisions are comprehensive and complex so they will need more time. The euro shot higher on ECB because Draghi made it very clear that it is not a question of 'if' but of 'when' ECB will start tapering asset purchases and contrary to previous reports, they feel confident enough to make the announcement in October instead of December. The central bank also raised its 2017 GDP forecast from 1.9% to 2.2%, which would be the strongest pace of growth since 2007. While they reduced their 2018 inflation forecast, the 0.1% drop was small and they left their forecast for 2017 unchanged. Draghi did not forget to mention the euro but his comments were relatively benign – he simply said the exchange rate is not a policy target but as it is important for growth and inflation, they must take it into account in their decisions.

Here's Why EUR/USD Spiked On Thursday

1. ECB signaled that a QE decision is coming in October
2. they upgraded their GDP forecasts to the fastest in 10 years
3. Draghi expressed little concern about the EURO and
4. U.S. yields tanked. Looking ahead, we expect EUR/USD to continue to appreciate into the October meeting taking out not only last month’s high of 1.2070 but also make a run for 1.2135, an area where EUR/USD found support in 2010 and 2012.

The outlook for the U.S. dollar is also grim as Hurricane Harvey and now Irma kill the chances of a December Fed hike. U.S. yields fell sharply Thursday as Irma makes its way toward the Floridian coast. Jobless claims also rose sharply and are likely to increase further as Harvey shut down Houston. Thursday’s report is the first evidence of Harvey’s toll on the U.S. economy. It is too soon to completely rule out a December rate hike but just as U.S. Fed presidents have warned, the next few weeks of data will be tainted by the storm and a very swift recovery in activity is needed to prompt the Fed to hike. However with Fed Vice Chair Fischer leaving office in October and Yellen possibly losing her job early next year, the central bank may refrain from any hawkish views until they see a positive turn in U.S. data. The dollar rebounded Wednesday on the debt deal but it is important to realize that the can has been kicked down the road and come December, the uncertainty returns and that could affect the Fed’s decision. So ultimately we don’t expect an extensive recovery in the greenback (USD/JPY could still break 108) and instead expect it to underperform the euro and commodity currencies.

The commodity currencies continued to power higher with the Canadian dollar rising to fresh 2-year highs versus the greenback. Although Thursday morning’s Canadian economic reports were weaker than expected with building permits falling -3.5% and the IVEY PMI index dropping to 56.3 from 60, a sign that manufacturing activity has slowed, monetary policy continues to drive the currency. Despite these reports, investors have clearly interpreted Wednesday’s Bank of Canada statement to mean that they are not done tightening. While a hike in October would be overly aggressive (that would be 3 quarter-point moves in a row), USD/CAD certainly appears poised for a move down to 1.2025 as investors look for further action in December. With that in mind, Canada’s latest labor-market report is due for release on Friday and according to the IVEY PMI, job growth continued to expand at a healthy rate in August.

The Australian dollar extended its gains above 80 cents and is now eyeing the July highs near 0.8065. With the weakening greenback driving AUD and NZD flows, investors completely ignored the stagnation in retail sales and significantly weaker-than-expected trade balance report. All 3 of Wednesday night’s Australian economic reports missed expectations with construction activity slowing, trade activity weakening and consumer consumption grinding to a halt. But all that seemed to matter little to investors who found comfort in RBA Governor Lowe’s less-hawkish comments. No economic data was released from New Zealand so NZD followed AUD higher.

GBP/USD broke above 1.31 on the back of U.S. dollar weakness. House prices increased in August according to Halifax, which is encouraging but at odds with a report from Nationwide last month. Although PMIs were released this week, sterling has mostly taken its cue from the market’s appetite for U.S. dollars and euros. That will change next week when the Bank of England has its own monetary policy announcement on the calendar. We could even see some sterling driven flows on the back of Friday’s U.K. industrial production and trade balance reports.