By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
The European Central Bank wants the euro to fall and that's exactly what the euro did after the monetary-policy announcement. Economists had been looking for asset purchases to continue for only 6 months beyond the previous soft end date and instead they were extended by 9 months from March to December. The amount of bonds bought per month between April and December was reduced to 60 billion euros instead of 80 billion euro, which at first glance may appear as if the ECB is slowing bond purchases. But 6 more months of bond buying at 80 billion equals 480 billion euros whereas 9 months at 60 billion is 540 billion euros. This misinterpretation is why EUR/USD popped then dropped after the rate decision. In total, this is a larger asset-purchase program than investors anticipated and on top of that, ECB President Draghi was more dove than hawk. He spent most of his press conference talking about the possibility of more stimulus, the downside risks the economy faces and indicated there is “no tapering on sight.”
What killed the euro was the fact that Draghi completely dismissed the idea of unwinding the Quantitative Easing program by tapering asset purchases. The ECB clearly does not want to jeopardize its fragile recovery by taking any steps that could reverse the uptrend in growth and inflation. The sell-off in the euro between September and December was crucial to the Eurozone recovery. Mario Draghi acknowledged the improvements in the economy and even upgraded the ECB’s 2017 GDP forecast while making it clear that Thursday’s actions involved the ECB seeking to “preserve stimulus” to “raise inflation.” CPI growth is still extremely low and based on the central bank’s own forecasts, the pace of growth is only expected to accelerate to 1.3% in 2017 and 1.5% in 2018. ECB does not expect CPI to return to target before 2020 and its outlook for only a modest year-over-year increase in price pressures explains why the ECB feels that monetary policy needs to remain easy. Going into the last rate decision of the year, the market was hoping for a 6-month QE extension, hawkish comments from Mario Draghi and a possible reduction in monthly bond purchases -- none of which they got from ECB. So instead of cementing the bottom for EUR/USD, Draghi created a top. We expect continued weakness in the euro, particularly against sterling, Swiss franc and Canadian dollar.
The U.S. dollar traded higher against all of the major currencies thanks to the sharp rebound in U.S. yields. Jobless claims dropped to 258K from 268K the previous week. The University of Michigan Consumer Sentiment Index is scheduled for release on Friday and the record high in U.S. stocks should make investors feel better about current and future economic conditions. We could see a continued rally in the greenback next week when the market shifts its focus to the Fed meeting, but gains should be limited by the prospect of a long pause after this month’s rate hike. Japanese markets continue to perform well as yen weakness and record high U.S. stocks drive the Nikkei higher. Just as the previous euro sell-off lent support to regional growth, the yen's sharp fall over the past few weeks will play a significant role in bolstering Japan’s economy.
Sterling also fell victim to U.S. dollar strength. No data was released overnight but after rejecting the 100-day SMA, GBP/USD extended its losses. With that in mind, sterling continued to trade in a narrow range versus the euro and U.S. dollar. Thursday was the final day of the U.K.’s Supreme Court hearings. While the government continues to fight the case on whether Mrs. May must get approval from Parliament before triggering Article 50, progress has been made with May offering to publish a Brexit plan in advance in return for adhering to the March 2017 deadline. Lawmakers have accepted the agreement with Labour Brexit spokesman Keir Starmar saying this forces the government to provide a plan with enough detail and clarity to end the circus of uncertainty… and to have clarity, scrutiny and accountability.” So it now seems that the process of exiting from the E.U. will begin in 3 months. Having a firm date could mean choppy trading in sterling early next year as investors analyze the headlines for signs of a hard vs. soft Brexit.
It was a mixed day for the commodity currencies with the Canadian and New Zealand dollars holding steady versus the greenback and the Australian dollar moving lower. Thursday morning’s housing reports from Canada were just as conflicting -- housing starts dropped but the new housing price index and building permits increased. Most importantly, Canadian yields rose sharply along side U.S. yields while oil prices rebounded. The Australian dollar underperformed on the back of softer data. Earlier this week we learned that the economy contracted by -0.5% in the third quarter and Wednesday night's trade deficit ballooned to –A$1.54 billion from –A1.22 billion. Not only was this the first increase in the deficit since June but it was also 2 times worse than the forecast for a significant improvement. This deterioration has some economists warning about recession but with imports and exports rising, we're not particularly concerned. China’s trade balance also missed expectations but traders shrugged off the report in response to the impressive rebound in imports and exports. No economic reports were released from New Zealand but credit card spending numbers were due Thursday night along with Australian home loans and Chinese inflation.