Solid US data and dovish ECB buoys Dollar
07/Sep/2015 • Currency Updates•
The divergence in monetary policies between Europe and the US was starkly on display last week. While there were no changes to the ECB’s policy stance on Thursday, President Draghi sent the Euro sharply lower at the start of the press conference by specifically mentioning a weaker Euro as a key lever to the European economic recovery. By contrast, the August payroll report out of the US confirmed that recent financial market jitters have had no impact on the US expansion, as unemployment continues to come down and wage growth remains modestly positive in real terms.
Between Thursday and Friday, the common currency gave up its gains to end up modestly down against the Dollar. Sterling had a rougher time of it, dropping nearly 1.5% against the Greenback.
Most emerging market currencies experienced sharp falls last week, in many cases to all-time lows. These ranged from the Brazilian real losing nearly 7% to a loss of 1-1.5% for most Asian currencies, with the rest falling somewhere in between. While the economic slowdown in these markets is undeniable, we think that the recent falls have left many of these currencies at very cheap levels that are starting to offer compelling value in many cases.
There was a hint of softness in the August business sentiment indicators. Nevertheless, these remain at levels consistent with growth in the 2-3% range and continuing falls in the unemployment rate.
All eyes are now on the September Bank of England meeting this week, when the minutes of the meeting and the votes of the MPC members will be released together with the actual decision. The minutes will be key in clarifying how much attention policymakers pay to recent market volatility. Perhaps overlooked is the fact that Sterling has weakened markedly, down fully 4% in trade-weighted terms. We expect the minutes to make reference to this positive development and therefore surprise the markets somewhat on the hawkish side.
The dovishness of the ECB meeting and the subsequent press conference startled the markets. Firstly, there was the unusually explicit reference to the currency. President Draghi stated that its level was important for growth and inflation. This, coming on the heels of downgrades to growth and inflation forecasts and the suggestion that we may see negative inflation again over the next few months, is quite significant in our view.
These developments confirm our view that the ECB is firmly committed to easing monetary policy further and that this commitment appears to include a lower Euro. In fact, we now think there is a 50% chance that we will see an outright expansion of the quantitative easing program before the year’s end.
We reaffirm our view that the common currency is due to resume a gently depreciating path against most other major currencies over the coming months, particularly against the US Dollar.
We were treated on Friday to yet another solid jobs report out of the US. Although the headline number was somewhat lower than expected, at 177,000 vs. expectations of around 210,000, the shortfall in the August number was more than compensated by net positive revisions of 44,000 jobs to the previous two months. Also we saw a better than expected decrease in unemployment and (crucially) a rebound in wage growth to 2.2% over the year. The August number has a strong tendency to be revised upwards anyway – an anomaly the BLS has not yet ironed out.
It must be noted that the current unemployment level of 5.1% is essentially below the Fed’s definition of full employment. It is true that other indicators of labour force slack are less positive (participation rate, for instance), but it is clear to us that the emergency monetary policy is no longer warranted. Friday’s labour report further confirms that the US economy remains largely unaffected by market jitters, and we continue to expect the FOMC to hike rates at its September meeting.