Euro rallies sharply against G10 currencies

Tom Tong09/Dec/2013Currency Updates

FX markets displayed some puzzling price action last week. The euro rallied sharply against both sterling and the dollar in spite of signs that the gap in economic performance between Europe and the rest of the major economies appears to be growing. Neither the strong payroll report out of the US, nor the exceptionally strong PMI numbers out of the UK seemed to faze investors rush for the euro, and the common currency rose between 1% and 1.5% against just about every major G10 currency.

GBP

The Autumn OBR turned out to be somewhat of a non-event. There were some token fiscal easing measures but their impact amounts to less than 1% of GDP, all of which is expected to be clawed back in subsequent fiscal years. More impactful was the November service business sentiment PMI. It pulled back slightly, but it remains above 60, at levels consistent with a strong expansion. Additionally, the forward-looking new business activity component of the survey remains near all time highs at 63. These levels are consistent with a repeat of the strong performance seen in third quarter’s GDP growth. Sterling failed to benefit from these strong numbers and the GBP lost ground against the euro, while trading almost in lockstep with the US dollar all week.

EUR

The ECB did not announce any new easing measures at its monthly meeting last week, as the markets and ourselves had been expecting. It did update its inflation and growth forecasts, extending them to 2015 for the first time. It now expects inflation, currently at 0.9%, to end 2014 around 1.1%, rising slightly to 1.3% in 2015. Given the large and persistent output gap that has opened up in Europe, its massive unemployment and the economic and political downward pressure on wages, we regard even these subdued levels are too optimistic and expect inflation to continue surprising the ECB to the downside.

USD

The key release of the week was, of course, the US payroll report for the month of November. The numbers were, once again, fairly strong. The US economy generated a net 203,000 jobs in November, clearly above expectations of 180,000. The unemployment rate dropped an unusually large 0.3%, and the all-important employment to population ratio (i.e. the % of working-age adults that have a job) jumped too. However, these latter figures were impacted by the October Federal shutdown, so it is best to compare them with the September levels. Over those two months, unemployment dropped from 7.2% to 7.0%, and the employment/population ratio was flat, still a more than respectable performance. The Federal Reserve will certainly be pleased by these numbers, and we maintain our view that the taper will start at the FOMC meeting late January. There is a small chance that it starts even sooner, at this month’s meeting. However, the FOMC has never started a tightening cycle in December. We expect tradition to hold in this case, even though the taper does not imply tightening in the same sense that the first rate hike in the cycle did in the past.

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Written by Tom Tong

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