By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.
Recent comments from Eurozone officials are making EUR/USD traders nervous because the greatest risk of selling euros is a shift in the ECB’s monetary policy plans. Over the past month the EUR/USD fell nearly 7% on the belief that the Europeans will ease when the Americans tighten but comments from ECB members Liikanen, Weidmann and Hansson suggests that a number of Eurozone policymakers do not feel the urgency to act. According to Hansson, there’s no need to cut policy rates now. His comments follow Tuesday’s similarly less-dovish views from Liikanen and Weidmann. Of course, there are also policymakers on the committee who think more needs to be done including Visco who said a lower deposit rate and more stimulus will be considered at the next meeting. Mario Draghi, on the other hand, refrained from talking about monetary policy at his speech Wednesday and the lack of dovish comments from the ECB head kept EUR/USD in consolidative mode.
While there are plenty of reasons for the ECB to ease, the lower the euro falls, the less pressure there will be on the central bank to act. A weak currency helps to boost growth and inflation – we’ve already seen the positive impact on German trade activity. If EUR/USD drops below 1.05 before the December ECB meeting, it could remove the need for immediate action buying the central bank time to see if a lower currency will be enough to stabilize the economy. Remember, the process of increasing stimulus is more difficult for the ECB than the Fed or BoE. Interest rates are already negative in the Eurozone and the Quantitative Easing program faces a number of political challenges. So if the central bank could delay the decision in the hope that it may not be needed, it probably would. For now we still believe the ECB will increase stimulus in December because expanding asset purchases is different from lowering rates but we are watching the headlines carefully because if more policymakers come out to speak against easing, the chance that the central bank will keep its program unchanged next month increases significantly.
Friday’s U.S. retail sales report is important for the dollar but unless spending contracts sharply, it will not alter the market’s expectations for Fed policy. In other words, we don’t expect U.S. consumer spending activity to pose a major threat to the dollar. In fact, with average hourly earnings on the rise and payrolls increasing more than expected, chances are the report will breathe new life into the dollar. The greenback traded lower against all of the major currencies Wednesday but traders shouldn’t make too much of the moves because the bond market was closed for Veteran’s Day. There has been nothing to change the Fed’s motivation and conviction to raise interest rates next month. Thursday’s initial jobless claims report should verify the ongoing recovery in the labor market while Fed Presidents Bullard, Evans and Dudley will most likely say that they may not be opposed to a rate hike in December, which is a live meeting.
One of Wednesday's best-performing currencies was the British pound, which traded sharply higher versus the U.S. dollar on mixed U.K. data. According to our colleague Boris Schlossberg, “UK employment hit its highest value on record rising to 73.7% but both wages and claimant count were a bit softer missing market expectations. UK wages rose only 3.0% versus 3.2% eyed while claimant count increased by 3.3K versus 1.6K forecast. Although the labor data from UK was a tad weaker than anticipated there was nothing in the report to indicate any material slowdown in demand. UK economy continues to perform at a steady albeit modest pace, which provides the BoE with ample time to maintain its neutral monetary policy. Cable drifted to a low of 1.5132 but quickly recovered as the report simply confirmed the status quo of UK monetary policy. It appears that for now the BoE is likely to remain pat even if the Fed moves on rates in December as UK policymakers see no inflationary pressures in the system to force a tightening.”
The Australian, New Zealand and Canadian dollars traded slightly higher versus the greenback. The latest Chinese economic reports were mixed with retail sales rising more than expected while industrial-production growth slowed. The Australian dollar was supported by an uptick in consumer confidence but the New Zealand dollar remained resilient despite a larger drop in food prices and slowdown in manufacturing activity. We continue to look for NZD to underperform the major currencies. Australian employment numbers were scheduled for release Wednesday evening and based on the drop in the employment component of the PMIs, the risk was to the downside for the report.