By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Investors sold euros aggressively Thursday taking the single currency within a few pips of its 4-month low. The sell-off was surprising considering that the central bank did not discuss extending Quantitative Easing, tapering and further rate cuts. They briefly discussed negative rates and options related to the scarcity of bonds available for purchase but no decisions on expanding the pool of purchases were announced. In fact, when ECB President Draghi started his press conference, EUR/USD surged to a high of 1.1039. But by the end of the Q&A session, it tumbled below pre-ECB levels. The euro was trading heavy before the rate decision and at the time, it looked like speculators wanted to gun for the June lows. When they felt that Mario Draghi’s views didn’t pose a huge threat to their trade, they returned to selling the currency. In other words, when they realized there wasn’t enough momentum for EUR/USD to hold 1.10, they viewed it as a green light to press the currency lower.
There’s no doubt that investors interpreted Draghi’s comments to mean that the central bank is still considering more stimulus in December and this view was shared by bond traders who took German and French yields lower after the rate decision. The German-U.S. yield spread declined Thursday, which is in line with the sell-off in EUR/USD. Yet we can’t help but point out that there was nothing overly dovish in Draghi’s speech, so the euro should be trading higher and not lower. We can’t rule out a final flush to 1.09 but we view anywhere below 1.0950 as a great place to buy EUR/USD for a move back up above 1.10.
The euro sell-off was also fueled by the rise in the U.S. dollar. USD/JPY briefly rose above 104 before settling right around those levels. U.S. data was mostly better than expected with the existing home sales rising 3.2%, versus 0.4% expected. The Philadelphia Fed index dropped to 9.7 instead of 5.0 like economists anticipated and jobless claims rose to 260K from 247K. While these reports reinforce the optimism reported in Wednesday’s Beige Book, none of these releases was a game changer for the Fed and unchanged Treasury yields confirm our view. Nonetheless, the Fed’s steady hawkish monetary-policy bias makes the dollar more attractive than many other currencies and makes us inclined to seek out dip-buying opportunities. For USD/JPY, that means anywhere between 103.20 and 103.80.
Thursday's worst-performing currency was the Australian dollar, which fell hard on the back of disappointing labor data. The PMIs were completely off base this month -- even though all three reports signaled an uptick in jobs, employment change fell for the second month in a row. Full-time employment dropped by -53K, which was the largest one-month decline since February 2009. The increase in part-time work kept the decline small but there’s nothing hiding the problems in this month’s report. The unemployment rate dropped to 5.6% from 5.7%, the lowest level in 3 years but that was due entirely to the drop in the participation rate. There have been recent adjustments to the methodology that has made the report more volatile but regardless, the numbers show a slowdown in the Australian job market that will probably be compounded by the slowdown in China. AUD/USD has had a nice run and a deeper correction is likely.
The New Zealand and Canadian dollars also moved lower. There was no New Zealand data to support the move as NZD followed AUD lower, but the drop in prices contributed to the sell-off in the loonie. USD/CAD is in focus Friday with retail sales and consumer prices scheduled for release. Economists believe that inflation and spending ticked higher, but after the Bank of Canada’s dovish comments this week, there’s a risk of a downside surprise. If improvements are seen, market participants are likely to shrug off the reports and overweight Poloz’s comments, which could give traders the opportunity to sell the currency at a higher level.
Sterling traded lower on the back of softer consumer spending numbers. Consumer spending stagnated in September including and excluding autos. All of this week’s U.K. economic reports were tepid with wage growth slowing and jobless claims rising slightly. Inflation ticked up but the increase was modest. The momentum that we saw last month is clearly fading and the weakness of sterling has failed to lend support to the economy. The focus remains on Brexit. The London High Court held hearings on this very issue earlier this week and said they would rule “as quickly as possible.” We don’t know exactly when that announcement will be made and that uncertainty could limit big moves in the currency. We know that the High Court does not believe that Brexit can be reversed but there’s a good chance that they will give Parliament the right to vote on the terms of exit from the European Union rather than let Prime Minister May maintain 100% of that power.