By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Forex traders refrained from taking big positions in EUR/USD ahead of the European Central Bank’s monetary-policy announcement. Wednesday’s trading range in was less than 50 pips, the tightest in 2 months. The ECB is widely expected to keep monetary policy unchanged – there should be no surprises on this front, but in his press conference, Super Mario could signal his willingness to don a Santa hat and deliver more stimulus in December. As shown in the table below, there has been widespread deterioration in the Eurozone and German economies since the last monetary-policy meeting. Slower activity was also reported in China and the U.S., so there are plenty of reasons for Draghi to be concerned about the global and domestic economies. Inflation remains low and other members of the ECB have already said more stimulus could be necessary.
However investors are not positioned for additional QE based on the EUR/USD’s recent price action. A lot of this sentiment has to do with recent comments from Draghi who seemed to be in no rush to increase stimulus. Earlier this month he said the effects of QE surpassed their expectations. Although the recent source of Europe’s troubles is Germany, Bundesbank President Weidmann believes more stimulus would not enhance growth and he said he's not particularly worried about the global outlook. As such, with two of the most important policymakers in the Eurozone reluctant to support more easing, investors are hesistant to take on large short-EUR/USD positions ahead of the ECB meeting.
Yet if ECB President Draghi is dovish or eases, EUR/USD could fall quickly toward 1.12. In fact if it were to go further, there are 4 ways that the ECB could crush EUR/USD this week. The most damaging scenario for the euro would be if the central bank cuts interest rates. However considering that interest rates are already -20bp, the chance of the ECB driving rates even lower is low. But the benefit is that it would broaden the type of assets the central bank could buy and require less logistical hurdles than more QE. The second option for the ECB would be to increase the size of its QE program. If they choose to do so without extending the end date, it would represent a more aggressive front-loaded operation, which would also be extremely bearish for the euro. The third option would be to expand the types of bonds it can purchase to bank and corporate bonds. The final and most-talked about possibility is a simple extension of the soft deadline for the current program beyond September 2016.
Of course with everyone talking about the inevitability of more QE from the ECB, the greatest disappointment would be optimistic comments from Mario Draghi. The chance may be low -- but not impossible -- given his comments earlier this month.
Wednesday’s strong gains in USD/CAD gave investors a taste of what they can expect for EUR/USD. The Bank of Canada left monetary policy unchanged, but its decision to cut its 2016 and 2017 GDP forecasts weighed heavily on the currency. While Central Bank Governor Poloz tried to sound a bit more optimistic by saying there are “clear signs Canada growth is picking up,” actions speak louder than words because the changes to the official economic forecasts left a greater impression on the market. The BoC sees the recent decline in oil prices shaving 75bp from GDP. Unfortunately a further decline in oil prices also added pressure on the currency. Canadian retail sales are scheduled for release Thursday and based on the drop in wholesale sales, we could be looking at another soft report that could take USD/CAD to 1.32.
Sterling is also in play on Thursday with UK retail sales -- this week's most-mportant UK Data point -- scheduled for release. Although GBP/USD traded lower Wednesday, the recent increase in wage growth and rise in the BRC retail sales monitor point to the greater possibility of a stronger release, which could lead GBP/USD to retest 1.55. BoE Governor Carney spoke on Wednesday about the upcoming EU Referendum. He said there is, so far, no impact on the economy from the EU Exit-talk and that the country benefitted from being apart of the EU while avoiding the drawbacks.
The U.S. dollar traded higher against all of the major currencies Wednesday but with U.S. rates falling, the move was more a function of strength in commodity currencies. No news has been good news for the greenback, but that changes Thursday with jobless claims and existing home sales due for release. Last week’s claims report was the lowest in 4 decades and a rebound is expected.
Meanwhile, the Australian and New Zealand dollars fell sharply against the greenback – both entirely driven by the decline in commodity prices.