Attempted rally by the Euro turned back by strong US economic data
08/Jun/2015 • Currency Updates•
Last week saw initially a strong rally in the Euro, driven upward by optimism about the negotiations on a new Greek package. However, beginning on Thursday afternoon, the common currency ran out of steam. Very strong data out of the United States, including but not limited to the May payrolls report, stopped the Euro rally in its tracks and drove it back down to finish the week up only a modest 1% against the Greenback and Sterling. Reports of further difficulties in the negotiations between the “institutions” and the Greek Government certainly did not help the Euro in the 2% fall it experienced from Thursday afternoon to the close of Friday.
We had moderately disappointing news out of the UK last week.
While the May manufacturing business sentiment PMI posted a small gain, from 51.8 to 52, the more critical services counterpart dropped sharply from 59.5 to 56.5. The 3.0 point fall is less dramatic than it seems at first sight, as the 56.5 level is still very high by historical standards, and the composite of both indices is still consistent with above-average growth above the 3% level. We saw better news from the mortgage markets, where approvals for new home purchase jumped to 68,100, a level that is consistent with an acceleration of overall home prices – not news that the Bank of England will be particularly happy to hear.
All in all, last week’s news is still consistent with our view of a first interest rate hike in the first quarter of 2016. This is earlier than the market is pricing and thus likely to support Sterling against most major currencies, except the Dollar.
Market focus last week was on the ECB policy meeting on Wednesday, and once again President Draghi studiously avoided any market-moving statements. Perhaps most noteworthy was Draghi’s lack of concern over the recent sell off in Euro Government bonds, whose yields have backed up sharply (albeit from extraordinarily low, even negative, levels). The tone of his recommendation, that financial markets “get used to volatility”, was unmistakable. Beyond the give and take of the press conference, it is worth noting that the staff forecasts for inflation and growth were kept essentially unchanged.
After a string of disappointing news over the past weeks, it was reassuring to receive confirmation of the strong downward trend in Eurozone unemployment. It fell again in April to 11.1%. These are still unacceptably high levels, but we are now far from the peaks above 12% seen in 2013, and the downward trend is now firmly established.
This positive trend in unemployment, lagged effects from currency depreciation, and the very low level of interest rates, should provide good support for European growth and we expect a modest acceleration to 2% over the next three quarters. This should be enough to continue driving unemployment downwards, with the help of further currency weakness against the US Dollar.
Strong economic data last week supported our view that first quarter weakness in the US was temporary, and largely due to both harsh winter weather and seasonal adjustments used by data collecting agencies.
The star was doubtlessly the May payroll report. Net job growth bounced back to 280,000, and 32,000 were added back to the first estimates of previous months. Average hourly earnings confirmed the strong tone of the report, rising 0.3% for the month and 2.3% over the last year, and converging upwards towards the 2.6% increase seen in the first-quarter employment cost index. The household survey did show unemployment ticking up to 5.5%, but this was caused mostly by an increase in the labour force participation rate, which rose faster than the number of jobs.
In addition to this good news, a spate of second-tier reports on auto sales, construction spending and foreign trade all ticked up pleasantly. We now expect second-quarter GDP to bounce back to 3%, and the Fed to hike rates, for the first time since 2007, in either July or September this year.