Here's Where The Euro's Headed

Why Euro Will Continue to Fall and Our Targets for the Move

The European Central Bank made the historic decision to start buying government bonds in March. While the announcement was widely anticipated, the size of the program exceeded everyone’s expectations, sending the euro sharply lower. The single currency dropped to its weakest levels in 11 years with the losses likely to extend to 1.1215 at minimum, the 61.8% Fibonacci retracement of the move that ran from 2000 to 2008. If this level is broken, 1.10 should be the next stop followed by parity. A move down to parity would require a strong commitment to monetary tightening by the Federal Reserve. The U.S. central bank is not expected to raise interest rates until the fall but if Fed officials continue to talk about the need for policy normalization, we could see a stronger rally in the greenback, which would add pressure on the EUR/USD. There were many questions going into the ECB meeting that have now been answered. We know that the ECB will be buying $60B a month until the end of September 2016 with more to come if necessary. They will buy only investment-grade bonds (which means no Greek bonds on the books), with national central banks on the hook for 80% of the losses. This is an aggressive and bold program that illustrates their commitment to fight deflation. Whether or not it is effective remains to be seen because QE has not helped the disinflation situation in other countries like the U.K. and Japan.

Another reason why we believe that the EUR/USD will continue to fall is because both USD/JPY and GBP/USD saw major losses of 500+ pips in the week after the first QE announcement. In the case of Japan, the yen rose but only because the market looked at QE as a desperate measure by the Bank of Japan after failed intervention a few weeks prior.

Our Top-10 Takeaways From The QE Announcement

1. Buying $60B per Month, Total Program at 1.2 Trillion Euros
2. Start Date March 2015. End Date Sept 2016
3. Investment Grade Only, Won’t Buy More than 30% of Issuer and 25% of each issue
4. Will Keep Buying Until Inflation Rises
5. Interest Rates Have Reached Lower Bound = No Negative Rates
6. ECB Retails Control of Design of Program
7. ECB will Hold 8% of additional asset purchases, 20% will be subject to risk sharing
8. Majority of Risk will be on National Central Banks
9. Cuts Spread on TLTRO to Zero > Making it more attractive
10. Some Purchases by National Central Banks Subject to Loss Sharing

Race to Cut Benefits the Dollar

The U.S. dollar is benefitting from the race to ease. In the past week, the European Central Bank, Bank of Canada, Swiss National Bank, the Danmarks Nationalbank, Reserve Bank of India and the central bank of Egypt increased stimulus in attempt to reverse the decline in price pressures and boost growth. Whether their efforts will pay off remains to be seen but what is certain is that their moves have made the greenback more attractive. The dollar traded higher against all of the major currencies Thursday, hitting milestones versus the euro, British pound and New Zealand dollar despite a larger-than-anticipated rise in jobless claims. The relatively small increase validates the positive outlook for the U.S. economy. If you believe that the Fed will raise interest rates this year, then this is but the beginning of a stronger rally in the greenback. We are still looking for USD/JPY to test its 121.65 high. Existing home sales and leading indicators are scheduled for release on Friday – a healthy rebound is expected.

Sterling Poised to Break 1.50

What is surprising about the ECB’s move is that it also drove other currencies to fresh lows. Aside from euro, the British pound and the New Zealand dollar dropped to their lowest levels in 1 and 2 years respectively as investors consider the possibility of the Bank of England and Reserve Bank of New Zealand reversing course and easing instead of tightening. We believe that such a dramatic turnaround is unlikely but the ECB’s decision certainly highlights the gravity of falling price pressures. Sterling came within a whisker of 1.50 and could break that level if Friday’s retail sales report surprises to the downside. Between the decline in oil prices and the drop in spending reported by the British Retail Consortium, chances are 1.50 will break and if that happens, there is no major support until 1.4825. Thursday morning’s U.K. economic reports were soft with the CBI Total Trends index falling.

New Zealand Dollar Falls to 2-Year Lows

All 3 of the commodity currencies extended their losses Thursday. A continued sell-off in the Canadian dollar is not surprising after the Bank of Canada’s monetary policy announcement. The 2% drop in oil prices is also putting pressure on the currency. We don’t think it will be long before USD/CAD hits 1.25. The sell-off in the New Zealand dollar on the other hand has been unusually aggressive. There hasn’t been any negative news flow out of New Zealand outside of the CPI number, which we believe should have stabilized given the rebound in dairy prices. The move could be linked to deleveraging and the increase in FX margins. The Reserve Bank of New Zealand meets next week and we don’t believe that they will be as pessimistic as the Canadians. In fact, they should be relieved that dairy prices rebounded. As such, we expect NZD/USD to find a bottom very soon. As for the Australian dollar, the losses were modest even though consumer confidence declined. The HSBC’s Chinese manufacturing PMI report was due out Thursday evening.