By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Look out below! The next stop for EUR/USD should be 1.10.
While the European Central Bank left monetary policy unchanged on Thursday, investors sold euros aggressively after the central bank sent a strong message to the market that it is not only ready and willing to increase stimulus but actively exploring ways to do so. Going into the meeting, we outlined 4 ways the ECB could crush the euro (see below) and on Thursday, Mario Draghi specifically mentioned each of these as possible options -- including the boldest move of lowering the deposit beyond its current level of minus 0.2%.
- Lower deposit rate
- Extend the end date for QE purchases
- Increase the size of the QE program
- Broaden types of bonds purchased
The central bank is worried about lower inflation, weaker global demand and slow structural reforms. That the ECB can support domestic demand through policy and lower oil prices are helping, but its hands are tied when it comes to foreign demand. One of the few ways it can encourage external demand is by weakening the euro through easier monetary policy. In fact, the ECB's outlook is so grim that some members wanted to increase stimulus immediately on Thursday. However a decision to expand stimulus is politically more difficult for the ECB than any other central bank. Nonetheless, by saying that the degree of policy accommodation must be examined in December, Super Mario is effectively telling us that he is ready and willing to don his Santa cap this winter. Expectations are now set for more easing.
EUR/USD is headed for a break of 1.10 because unfortunately, the strength of Thursday's 2% decline indicates that investors were not positioned for dovishness. If they were, the currency pair would not have experienced its largest one-day drop in 2 months. Typically, this type of strong move has at least a 1-to-2 cent continuation. 1.10 is very significant support in EUR/USD and we expect that level to be tested and breached for a possible drop to 1.08. Eurozone PMIs are scheduled for release on Friday and chances are that the reports will exacerbate selling by confirming the slowdown in the region's economy.
The U.S. dollar traded very well Thursday, rising sharply against all of the major currencies. Not only did the greenback benefit from the Fed's hawkish policy stance, but jobless claims continued to fall and existing home sales rose significantly more than expected. The four-week moving average of claims dropped to its lowest level in over 40 years. Although the U.S. non-farm payroll report showed job growth slowing, layoffs have been at historically low levels, which suggests that companies are just waiting for signs of stronger demand before stepping up hiring. The housing market also remains firm and collectively, these 2 reports should ease the Fed's worries about the economy. The dollar should remain firm as long as the Fed is still thinking about tightening at a time when other major central banks are thinking about easing.
Thursday's second-best performing currency was the New Zealand dollar. While no economic reports were released Thursday, New Zealand is one of the few countries seeing a revival in growth. The recent increase in dairy prices has gone a long way in stabilizing the outlook for the economy. We've even seen consumer confidence and business activity tick up as a result. The RBNZ will be happy with the latest economic reports, but if NZD rises any further, its concern about a strong currency could return. Meanwhile, the Australian dollar ended the day unchanged. Business confidence dropped in the third quarter, which is not surprising considering that Chinese growth slowed during that period.
USD/CAD pulled back slightly after Wednesday's strong gains. We are actually surprised that the currency pair did not decline further given the upside surprise in Canadian retail sales. Consumer spending increased 0.5% in August after rising an upwardly revised 0.6% in July. It has been a while since we have seen positive Canadian data and Thursday's report was a breath of fresh air. Oil prices also edged slightly higher but broad-based demand for the greenback along with the Bank of Canada's lowered GDP forecast kept the currency pair supported. Consumer prices are scheduled for release on Friday and easier inflationary pressures could reinvigorate the rally in USD/CAD.
Sterling traded sharply higher versus the euro and only marginally lower versus the U.S. dollar. U.K. retail sales rose 4 times more than expected. Even though spending in August was revised lower, the upside surprise in September more than offset the prior month's weakness. Sterling did not benefit much from the move but we believe that after Thursday's report, it is poised for stronger gains, particularly versus euro and the commodity currencies. GBP/USD looks attractive between 1.5300 and 1.5350.