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Why Euro Broke Support Despite ECB Optimism

Published 27/04/2018, 03:54 am
Updated 09/07/2023, 08:31 pm

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

The euro went on a wild ride Thursday after the European Central Bank’s monetary policy announcement. The single currency shot up to a high of 1.2210 as Mario Draghi expressed his confidence in the economy but when the press conference ended, it began a deep slide that erased all of its post-ECB gains, taking EUR/USD below 1.2100 to its the weakest level in 3 months.

EUR/USD simply couldn’t overcome the dollar’s strength as the move coincided with a broad-based rally in the greenback. Nonetheless, after leaving interest rates unchanged, ECB President Draghi was surprisingly upbeat during his press conference. He downplayed the recent deterioration in data and talked primarily about their confidence in their outlook for solid, broad-based growth and their view that inflation will converge toward their goal. He saw the downside risks as mostly global and the unexpected declines in data to be temporary because they are “still above historical averages” and Draghi also felt that there is less exchange-rate volatility. While he refrained from discussing their monetary-policy plans including the end of asset purchases, it is clear that the ECB’s goal on Thursday was to reaffirm their confidence in the economy, which should have driven EUR/USD higher and not lower.

The decline in Treasury yields should have also lifted the pair but German rates fell more than U.S. rates, so the yield spread favored EUR/USD weakness. At the end of the day the ECB will not be raising interest rates until 2019 whereas the Fed could lay the groundwork for a June rate hike when they meet next week. So in a nutshell, EUR/USD broke below 1.2150 support despite the ECB’s optimism because it failed to overcome the dollar’s strength, because the yield spread still favors EUR/USD weakness and because in many ways, ECB policy will trail well behind the Fed this year.

The U.S. dollar held onto its gains, shrugging off the decline in Treasury yields. U.S. data was better than expected with jobless claims falling to its lowest level in 49 years. A large part of the decline was due to spring-break seasonality but the less volatile 4-week moving average also fell to 229K from 231K. Durable goods orders rose 2.6%, against expectations for 1.6% increase while the trade deficit shrank to -$68B from -$75.9B. First-quarter GDP numbers are scheduled for release Friday and while investors are positioning for a strong report, the drop in non-defense capital goods orders, the stagnation in durable goods ex transportation, weakness in retail sales at the start of the year point to a softer release. Therefore, if GDP falls short of expectations, we could see end-of-week profit taking in the greenback.

The Bank of Japan has a monetary policy announcement this evening and will be releasing a barrage of economic reports including CPI, jobless rate, industrial production and retail sales. The BoJ firmly believes in the need for easy monetary policy so no changes are expected but they will be releasing their latest economic projections including their first forecasts for 2020.

Like the euro, sterling gave up its earlier gains to end the day unchanged versus the greenback.
First-quarter UK GDP numbers are scheduled for release on Friday. This is the most important piece of U.K. data on the calendar this week and it is expected to show growth slowing in the first 3 months of the year. However with trade and retail activity improving, we believe that the risk is to the upside for this report. The U.K. government also held a debate Thursday on whether Britain should remain in a customs union. Interior Minister Amber Rudd cast doubt on May’s plan to leave the union as he’s worried that it would hurt Britain’s ability to sign its own trade agreements. No vote was held but this is a lead-up to a binding vote in May or June.

The Canadian and New Zealand dollars ended the day lower against the greenback while the New Zealand dollar finally stopped falling after 7 days of extensive weakness. New Zealand’s trade balance and Australia’s producer price reports were on the calendar Thursday evening. The downtrend for all 3 commodity currencies remain intact, so Thursday's recovery is still nothing more than relief rally for the time being.

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