Like many major currencies, the euro dropped to fresh multiyear lows against the U.S. dollar. Nine days have now passed without a rally for the single currency – this is the longest stretch of weakness that we have seen since June. Yesterday’s moves took the euro to its lowest level against the dollar since January 2006. At this stage there is very little reason to doubt that euro will test its 2005 low of 1.1639.
Each piece of incoming data has reinforced the market’s expectations for quantitative easing from the European Central Bank. There’s only 14 days to go before the ECB meeting and we expect the currency to remain under pressure until then. Yesterday morning we learned that consumer prices dropped 0.2% in the month of December. The sharp fall in oil prices can be blamed for causing inflation to fall for the first time since 2009. This presents a big problem for the ECB which is mandated to keep inflation around 2%. Although core prices increased, that along with the drop in German unemployment won’t alleviate the European Central Bank’s concerns about the need for more stimulus. While one month of negative price growth does not equate to deflation, it increases the risk of the Eurozone falling into a deflationary trap.
With prices and retail sales growth slowing in Germany, officials may no longer be able to deny the need for Quantitative Easing. Based on the price action of the euro, investors firmly believe that at the end of the day, the Germans won’t stand in the way of the ECB doing what they feel is necessary. Between the drop in CPI, decline in oil prices, ongoing political uncertainty in Greece and a shooting/terrorist attack in Paris, there’s very little reason for investors to want to buy euros. We believe that from both a technical and fundamental perspective, the euro should make a run for its 2005 low of 1.1640. Will there be a rally before then? Possibly but only if Friday’s U.S. employment report surprise to the downside.
The US dollar traded higher against most of the major currencies yesterday and while it may be tempting to attribute the move to better than expected US data, the rally was underway well before the North American session. A rebound in US Treasury yields and weaker European data reminded investors that growth and monetary policy differentials will boost the dollar in the year ahead. The path of least resistance is still upward for the greenback and unless there is a significant disappointment in non-farm payrolls, any corrections will be shallow. According to this yesterday’s ADP report, 241k jobs were added to corporate payrolls, up from 227k. The trade balance also dropped to an 11 month low as cheaper oil reduced the cost of energy imports. Considering that the same should be true for December data, trade should contribute positively to Q4 GDP. Even though the dollar pulled back slightly after the Fed minutes, they did not pose a threat to our outlook for Fed tightening in Q3/Q4. According to the minutes, Fed officials “saw a rate rise unlikely before April,” which is consistent with the market’s forecast for a rate hike in the second half of the year. While the Fed is worried about weaker global growth, they also feel that inflation would only be temporarily depressed by the stronger dollar and lower oil prices. Nonetheless they said they will be “patient” about raising rates which means that for the time being, they are still in wait and see mode with new data determining how quickly they will move. These comments led to a slight pullback in the greenback but we continue to view any declines as an opportunity to buy at lower levels.
We have been looking for sterling to drop to 1.50 versus the U.S. dollar and today it came within 55 pips of that target, dropping to a fresh 1 year low in the process. However an intraday recovery helped GBP/USD settle well off its lows by the end of the North American trading session. Considering that this is the longest stretch without a positive day for GBP/USD since September, there’s a significant risk of a relief rally. Of course, we’ll view this as an opportunity to sell but closer to 1.53 as the recent deterioration in U.K. data continues to weigh on the currency. This week’s Non-Farm Payrolls report poses some risk for GBP/USD especially if NFPs rise less than expected but unless there is a major downside surprise (which we do not anticipate), it will not take the Fed off its course of tightening and GBP/USD out of its downtrend. There were no major U.K. economic reports scheduled for release today but the improvement in BRC shop prices overnight is interesting because it implies higher prices. Tomorrow the Bank of England has a monetary policy meeting and no changes are expected. The BoE plans to release minutes alongside their rate decision but that won’t begin until March. So for the time being, the rate decision will be a nonevent for the currency.
The Canadian and New Zealand dollars traded higher against the greenback yesterday while the Australian dollar ended unchanged. These moves represented an intraday turnaround as all 3 commodity currencies started the North American trading session in negative territory. There was quite a bit of volatility in oil but by the end of the day, prices rebounded which helped the CAD recover its losses. Yesterday we saw just how much damage higher oil prices can have on Canada’s economy. The country’s trade deficit hit a 2-year high in November as exports dropped 3.5%. Considering that oil prices fell another 20% or approximately $20 a barrel in December, the deficit is likely to have worsened, leading to more overall weakness in Canada’s economy. Manufacturing activity beat expectations but slowed from the previous month. The employment component of the IVEY PMI report declined, signaling possible weakness in Friday’s Canadian employment report. Some market participants believe that stronger U.S. growth will lift the Canadian economy, the pain of lower oil prices should precede that with Canadian data weakening before it improves and for this reason, we view pullbacks in USD/CAD as an opportunity to buy at lower levels. No major economic reports are expected from the 3 commodity producing countries over the next 24 hours, so keep an eye on commodities.
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