Euro leads all major currencies down against the Dollar
26/Jan/2015 • Currency Updates•
All eyes were fixed on the ECB announcement on Thursday, and once again President Draghi did not disappoint. Two-and-a-half long years after Mario Draghi declared he would do “whatever it takes” to protect the Euro, the European Central Bank (ECB) has finally delivered. The long-expected quantitative easing (QE) program was launched. The details were mixed, with a larger size than the market had expected but a low level of risk sharing among EU sovereigns. In a case of “sell the rumour, then sell the news” markets reacted by pushing the Euro sharply to fresh eleven year lows, down 3% against the US Dollar. In fact, the common currency led all major currencies down against the Dollar, which rose anywhere from 1% to 3% against most of its G10 peers to fresh cycle highs.
The Bank of England also made headlines this past week. The publication of the Minutes for the January meeting revealed that the two dissenters that were calling for an immediate interest rate hike have changed their minds and the MPC is now unanimous in keeping rates at a record-low 0.5%. Members are clearly more worried than we expected about the low levels of inflation and the possibility that a deflationary mind-set may take hold before inflation levels rebound. Therefore we are now pushing back our forecast for the first rate hike into the last quarter of 2015.
Aside from the Bank of England’s news, labour market releases were positive. Unemployment fell to 5.8%, wage growth accelerated modestly to 1.7% YoY, and total hours worked increased to 2.2% YoY. All three of these critical indicators are consistent with a labour market that is tightening fairly rapidly. Perhaps this is the reason why Sterling held up rather well last week, falling just under 1% against the Dollar but rising by over 2% against the Euro.
It is finally here. The much awaited QE programme was finally officially announced by the ECB on Thursday afternoon. The devil, however, was in the details, and these were mixed. Critically, the size of the purchases will be very large. Starting March of this year, the central bank will purchase public and private sector securities for total of 60 billion Euros a month, more than the 50 billion Euros priced in by markets. The program will continue until the end of September 2016, or longer if inflation fails to rise back to the target; the importance of this open-ended commitment has been under appreciated by the financial press, in our opinion. The total size will therefore amount to no less than 1.2 trillion Euros, and likely more.
On the negative side, and in a concession to Germany and the Netherlands, who actively opposed the scheme, only 20% of the additional asset purchases will be subject to a regime of risk sharing. In other words, 80% of bond purchases will therefore be undertaken by national central banks. 20% risk sharing is better than no risk sharing, and at any rate this technical detail will have no immediate impact on the effectiveness of the program. However, this concession extracted by Germany underscores the lack of commitment to a Eurozone-wide fiscal policy without which markets will continue to question the long-run viability of the common currency.
Mostly second-tier reports out of the US last week, which were understandably overshadowed by the headlines across the Atlantic. Housing starts and mortgage applications both surprised to the upside. A healthy housing market will go a long way towards satisfying the Fed that the economy can handle an interest rate hike, and therefore these data points provide support for our view that the first hike will come as early as April. The only factor that could plausibly delay Fed hikes would be the strength of the Dollar, which rose strongly yet again last week. However, in the past Fed policy has been largely independent of the level of the US Dollar. Hence, we are sticking to our mid-second quarter call.