Euro resumes downward trend after Draghi hints at further monetary easing
24/Nov/2014 • Currency Updates•
It was a relatively quiet week until Friday morning. ECB President Draghi once again stole the spotlight in a very significant speech where he hinted that quantitative easing is coming sooner than the market expects. Our expectations for further easing measures as soon as the December meeting are thus fully validated, and therefore nothing (aside from still stretched short positioning) seems to stand in the way of a resumption of the downward trend in the Euro, which last week dropped against every other major currency with the exception of the Japanese Yen. The parallel devaluations of EUR and JPY, driven by the dramatic divergences in monetary policy across different currency blocks, is shaping up as the major currency theme for the coming year, while Sterling struggles to keep up with US Dollar strength. The Greenback is now very close to marking five-year records in trade-weighted terms.
The Bank of England must have welcomed the inflation news released last week. YoY inflation edged up to 1.3%, and core inflation remains reassuringly close to the BoE inflation target at 1.5%. The other big news of the week was the release of the MPC minutes. These were perhaps a touch more hawkish than expected. The two votes for immediate hikes remain, and the range of views among the seven doves seems to be widening. Interest rate markets however seem to be pricing no hike until well into the second half of 2015. We think that this is too long and continue to pencil in a BoE hike for late spring 2015, so long as we don’t see any political or economic accidents out of the Eurozone, which remains the largest tail risk in world financial markets.
Last week was a very difficult one for the common currency. First, the November PMI leading indices of business sentiment unexpectedly took another turn for the worse, dashing the hopes for stabilisation that had developed over the previous couple of months. The composite headline PMI fell 0.7 to 51.4, which more than negates the hopeful improvement we had seen in the indices in October. Then, on Friday, President Draghi surprised markets in a very significant speech. He transmitted a clear sense of worry over the deterioration of Eurozone data. He also dismissed worries that quantitative easing (QE) would not be meaningful in the Eurozone given already low levels of sovereign interest rates, suggesting that an announcement in this direction is imminent. Although he did not allude directly to this in his speech, we suspect that the startling success of anti-establishment politics in the periphery (and France) is spurring this rush to action on the part of the ECB. Whatever the cause, QE is deeply welcome and the only worry is that it may come too late.
The Federal Reserve also received welcome news from the inflation front last week. While the headline number was unchanged at 1%, dragged down by dropping energy prices, core inflation was up 0.2% for the month, lifting the YoY rate to 1.8%. In the absence of first-tier data releases, industrial production and housing indicators continue to paint a picture of moderate economic strength, consistent with growth around the 3% mark, and definitely “on track” for Fed hikes early in the second quarter of 2015.