Euro soars as Draghi's expanded stimulus for the Eurozone disappoints markets
07/Dec/2015 • Currency Updates•
The European Central Bank failed to live up to the enormous expectations that had been built around its December meeting last week. While the package of stimulus measures was significant, including a cut of the deposit rate and an expansion in the duration of the quantitative easing programme, it fell short of the shock and awe that investors had been led to expect by consistently dovish communications from ECB President Mario Draghi.
Further, the disappointment highlights that Bundesbank hawks within the ECB Governing Council are still able to conduct effective opposition to ECB easing.
The net result was a massive short covering rally in the currency markets, as consensus bets against the common currency were unwound in thin markets and the Euro soared against both the US Dollar and Sterling. Unwinds of consensus positions also brought pain to stock and government bond markets, and both asset classes ended the week significantly down.
The strong payroll number in the US, which more or less guarantees a Federal Reserve interest rate hike later this month, did not do much to help the Dollar, which ended the week down across the board against most major currencies.
Major currencies in detail:
We had a data-light week in the UK.
The PMI business indices came out strong, particularly in the services sector, which rose to 55.9 from 54.9. This provides some reassurance that the modest slowdown we saw in third quarter GDP numbers has not carried over into the end of the year, and we can expect GDP growth to rebound to the 2-3% range.
This had no impact on currency markets, which were wholly preoccupied with the ECB expectations game. Sterling continues to behave as a “Dollar light” currency, and plummeted in tandem with the Greenback against every other G10 currency save the Japanese Yen.
Expectations for the ECB meeting had been built up to such feverish levels that it was perhaps inevitable that markets would be disappointed.
In the end, the deposit rate was cut by just 0.1% to -0.3%, and QE was extended through March of 2017 from September of 2016, which implies the purchase of an additional 360 billion Euros of bonds. Also, and perhaps somewhat overlooked by the markets, the range of eligible bonds was expanded to include regional and municipal bonds.
However, there was no increase in the monthly target of 60 billion Euro purchases and, while interest rates were pushed further into negative territory, it was only marginally so, with no effort to push the boundaries of the ability of money markets to tolerate firmly negative rates.
We think that these measures are meaningful, whatever market expectations might have been. However, the ECB willingness to disappoint markets suggests that the Bundesbank hawks hold more sway than we had expected. This is a worrisome development, and the massive post-meeting Euro rally won’t have been welcomed by President Draghi.
One of the key effects of a weaker Euro would be to boost competitiveness of Eurozone exports, and push inflation closer to the 2% target. We keep unchanged our target of 1.05 for EURUSD at year end, and expect most of last week’s gains to be given back over the next few weeks as short Euro positions are liquidated and the market becomes less of a one-way bet. Therefore, we feel last week’s events and move in the Euro are likely to present a good opportunity for Eurozone importers.
Friday saw yet another solid payroll report out of the US.
The US economy added a net 211,000 jobs in November, and the previous month’s result was revised upwards resulting in a three-month average of close to 220,000. Unemployment was unchanged at 5%, but this was mostly due to labour force participation inching up by 0.1% and soaking up the increase in jobs. Average pay for all workers has increased at a 2.4% annualised rate over the past three months, above both headline and core measures of inflation.
The ECB meeting on Thursday stole the spotlight from Friday’s US labour report, but the reassuring jobs number confirms our expectations for a first Fed rate hike at their December meeting. Thus, given the large correction in the market after Draghi’s announcements, we would expect the Dollar to recover its losses in the lead up to this potential rate hike.
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