By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Euro: Look Out Below
One of the worst-performing currencies Monday was the euro, which lost more than 1% of its value against the U.S. dollar. Between Friday and Monday, EUR/USD dropped close to 300 pips and there’s a very good chance that this week we'll see a deeper slide in the currency. Over the past month there has been an extremely consistent message coming out of the European Central Bank. Policymakers expressed their unified frustration with the region’s fragile recovery, low level of inflation and global market uncertainty. That includes ECB members Praet and Nowotny who spoke on Monday. While neither of these gentleman mentioned Quantitative Easing, earlier this month both said the program could be adjusted if needed. The primary focus this week will Mario Draghi’s hearing in Brussels. This is a quarterly grilling by the European Parliament’s Committee of Economic and Monetary Affairs. If the head of the European Central Bank confirms that they could boost the Quantitative Easing program, EUR/USD could test 1.10. While the euro has fallen sharply, it is up nearly 4 cents from its July lows and despite Monday’s increase, the price of crude is 8% lower than 2 months ago, giving the ECB more reasons to be cautious than optimistic.
The second and third reasons why euro may crash this week is data. PMIs are scheduled for release along with the German IFO report. Investors are waiting for weaker data to confirm their bearish outlook and if either one of these reports surprise to the downside, it could trigger a nasty decline in the currency. Given the concerns of European policymakers and the sharp decline in the outlook component of the ZEW survey, we believe the risk is to the downside for these reports. Technically the level at which the EUR/USD rally failed last week is a significant one. 1.1466 capped gains in the currency pair back in May and again in June and has now marked the top for the currency pair.
Uncharacteristically optimistic comments from U.S. Fed President Lockhart also drove the dollar higher, exacerbating the decline in the currency pair. Lockhart is typically one of the more dovish voters of the FOMC, but Monday’s confidence that liftoff would begin later this year and his comment that the September FOMC decision was a close call was unusually hawkish. He indicated that the labor market has shown substantial improvement, pointed out that the Fed’s job is to focus on the domestic economy and it is ready for policy normalization. He added that a 25bp rise won’t have significant impact and therefore October is a “live meeting.” These comments helped investors shrug off a weaker existing home sales report and pushed the dollar higher against all of the major currencies.
Monday’s focus was on euro but the New Zealand dollar was the worst-performing currency. The move had everything to do with data. According to Westpac's survey, consumer confidence dropped to its lowest level in 3 years in the third quarter. Confidence in the rural sector has been hit the hardest with more than half of the country’s famers looking for conditions to worsen in the coming year. Consumers in general are more cautious and even though dairy prices increased, farmers have yet to feel the improvement. This explains why credit card spending growth slowed in August. These numbers reinforce the Reserve Bank of New Zealand’s dovish bias. Later this week we have New Zealand consumer confidence numbers scheduled for release.
In contrast, Sterling and the Canadian dollar ended the day unchanged. Rightmove house prices increased more than expected in September and the health of the housing market sheltered the British pound from losses. More importantly, sterling rates benefitted from the talk of an October rate rise from the Federal Reserve. Public sector finances are scheduled for release Tuesday and borrowing is expected to have increased significantly in August.
Bank of Canada Governor Poloz made no mention of monetary policy in his speech on Monday but his comments were more optimistic than cautious. He downplayed the economy’s reliance on oil by saying it is highly diversified and pointed out that the lower Canadian dollar is cushioning the impact of lower oil prices. Poloz is also optimistic about Chinese growth and sees the country gearing down to a more sustainable pace. The Canadian dollar did not react to these comments or the +3% rise in oil prices but these two factors should cap the gains in USD/CAD.
Finally the Australian dollar also traded sharply lower. No economic reports were released but the more than 2% decline in copper prices played a big role in the weakness of the currency. Technically, AUD/USD looks poised for a steeper decline to 70 cents but whether that move occurs hinges on this week’s Caixin Chinese PMI manufacturing report.
Note – Japanese markets remained closed for the next 2 days.