By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
- Why EUR Hit 11-Year Lows Ahead of ECB
- It Is Not About the Dollar
- CAD Soars after BoC Leaves Rates Unchanged
- NZD Extends Gains as Dollar Weakness
- AUD Shrugs Off Stronger Data
- GBP Extends Losses on Weaker PMI
Why EUR Hit 11-Year Lows Ahead of ECB
With less than 24 hours to the European Central Bank's monetary policy announcement, investors sold euros aggressively driving the single currency to its weakest level versus the U.S. dollar in more than a decade. When the ECB last met in January, it unveiled a massive Quantitative Easing program to boost inflation and growth. At the time, it was still working out the details, which they promised to announce at the next meeting. On Thursday they are expected to provide the specifics on how the program will work and, based on the sharp decline in the currency, EUR/USD traders are bracing for the worst. However we doubt that the details of the program will be shocking and view the decline in the euro as a reflection of the reality that Quantitative Easing is coming. This month, the ECB will hit the 'go' button on a 1 trillion euro asset-purchase program aimed at flooding the market with liquidity. That would not be so euro negative if the Federal Reserve were doing the same thing but not only did the U.S. central bank end its 5-year QE program last October, it is looking to take the next step and raise interest rates. It is the reminder of this divergence that has driven EUR/USD to fresh 11-year lows.
How far the EUR/USD falls, however, will be determined by Mario Draghi's level of dovishness and pessimism. Given the recent improvements in Eurozone data and positive comments from the central bank governor, we continue to believe that the currency pair is near a bottom. The euro will rebound if the ECB upgrades its growth forecast. But in the meantime, here's what we know and don't know about ECB QE.
What We Know About ECB QE
- ECB will buy EUR 60 billion per month until at least September 2016 = Over EUR 1 trillion
- Most of the purchases will be sovereign bonds
- Program will begin in March and could last beyond September 2016 if inflation does not reach 2%
- National Central Banks will start buying their own bonds and bonds issued by European institutions
- ECB will buy 8% of the bonds, most losses will be assumed by national central banks
What We Don't Know
- Will the program begin early, middle or late March?
- Is the ECB flexible on buying until 2% inflation is reached?
- Will National Central Banks be allowed to buy other assets?
It Is Not About the Dollar
While we would love to attribute Wednesday's decline in the euro, British pound and Canadian dollars to the market's demand for U.S. dollars, that would not be completely accurate because the greenback did not see broad-based gains. The dollar traded higher versus European currencies but failed to rally against the Japanese Yen, Australian and New Zealand dollars. There's no question that better-than-expected U.S. data and expectations of an earlier rate hike by the Federal Reserve created some demand for dollars but the prospect of QE from the ECB, weaker data from the U.K., less dovish comments from the Bank of Canada and stronger Australian data also contributed to the moves. In other words, it was not just about the dollar on Wednesday. We continue to be surprised by the market's focus on a June tightening. Service-sector activity grew faster than expected last month and the employment component of the report rose sharply, signaling strength for Friday's non-farm payrolls report, which is but one upside surprise after a series of disappointments. Also, the details of the report showed new orders and production slowing, which is not a good sign for the service sector. In addition, Federal Reserve President Evans -- a voting member of the FOMC -- called for rates to be raised in 2016 instead of 2015. Fed President George was a bit more aggressive, saying that waiting to raise rates could put policy behind, although she is not a voting member of the FOMC this year. Finally, the tone of the Beige Book was optimistic with the Federal Reserve seeing growth across most regions and industries.
CAD Soars after BoC Leaves Rates Unchanged
Investors bought Canadian dollars aggressively after the Bank of Canada left interest rates unchanged. While back-to-back rate cuts was unlikely, most investors expected the BoC to maintain a dovish bias and leave the door open to additional easing. However, the central bank described inflation risks as more balance, called the current degree of stimulus appropriate and said that crude prices and Q4 growth are close to expectations. These comments indicate that the central bank has shifted to neutral and is no longer looking to lower interest rates. It is for this reason -- and not just its decision to keep rates steady -- that drove the Canadian dollar sharply higher Wednesday. The rebound in oil prices also helped lift the currency. While USD/CAD has yet to break out of its 1.2350 to 1.2700 range, we believe that it should only be a matter time before support gives way. The New Zealand dollar also extended its gains but the Australian dollar ended the North American trading session unchanged versus the greenback despite stronger service-sector activity and steady fourth quarter GDP growth. AUD remains in focus with Australian retail sales and trade data scheduled for release Wednesday evening.
GBP Extends Losses on Weaker PMI
The British pound extended its losses following weaker-than-anticipated service-sector activity. Unfortunately we did not see an increase in all 3 of the PMI reports Wednesday, which triggered a broad-based decline in sterling. According to our colleague Boris Schlossberg, "UK PMI Services report came in mixed putting more downside pressure on cable." The data printed at 56.7 vs. 57.6 eyed falling below estimates for second month out of the past three. The underlying data however was not as weak as the headline number with new orders and employment and prices all rising. The report shows that the UK economy remains stable and healthy and its largest sector continues to sit comfortably in expansion territory. According to David Noble at CIPS, "The protracted length of backlog accumulation indicates that the recovery may now be sustainable following the rapid growth of last year." Nonetheless cable fell victim to overall dollar strength with the pair dropping to a low of 1.5252.