Fundamental Forecast for Euro: Neutral
The Euro and Swiss Franc were under more intense pressure versus the British Pound, hitting new yearly lows.
EURUSD was vulnerable going into Thursday and a breakdown may have just started after the strong US NFPs.
The Euro experienced a minor setback this week against most of its major counterparts, losing the most ground to the increasingly resilient and impressive British Pound. Even EURUSD had a late-week letdown on the back of the US labor market showing additional fortitude, as the US unemployment rate fell to a post-recession low of 6.1%, the lowest since September 2008. The recent barrage of important data on both sides of the pond suggests a widening differential in central bank policy, leaving the Euro at a disadvantage against the British Pound and the US Dollar going forward.
As traders were buying US Dollars on Thursday after the June US labor
market showed the fifth consecutive month of jobs growth above +200K,
European Central Bank President Mario Draghi was simultaneously holding
court after the ECB policy meeting; the Governing Council’s latest actions did little to help support the Euro.
In absence of new policy action, ECB President Draghi’s greatest
contribution on Thursday was to remind traders that not only would
interest rates remain low for an extended period of time, but that the
ECB was also intensifying prep work related to asset-backed securities
(ABS) purchases.
The problem for the ECB with ABS purchases, which is why the market
hasn’t taken the threat as a significant reason to drive Euro exchange
rates lower, is that the ABS market in the Euro-Zone is not nearly as developed as it is in the United States;
and therefore the amount of ABS purchases potentially necessary is
difficult to quantify. The ECB, up until this point, was not (and still
truly isn’t) necessarily aware of how big the ABS market was and how
strong of a purchase program they would need to design.
While the threat of a major LSAP is certainly brewing, the clout
behind the ECB’s potential €1 trillion TLTRO is rather weak, at least
from the perspective that it could keep downside pressure on the
EUR-crosses in a meaningful way. Simply put, these are not carte
blanche liquidity injections; the rules published by the ECB on
Thursday make well-clear their intention to improve liquidity channels
and reduce credit fragmentation across the Euro-Zone.
If the TLTROs are effective, they end result will be capital used to
boost organic growth opportunities rather than speculative reach for
yield (in the US, the UK, and the Euro-Zone, open-ended QE is widely
perceived as free money for financial institutions at the expense of
taxpayers and savers, so the ECB is being careful to craft a program
that won’t fan the speculative flames). Over time, the TLTROs could even prove to be broadly EUR-positive, but not for several months or years.
For now, the Euro is stuck with a central bank in holding position,
preparing for its next move, as it waits and observes what its prior
actions have resulted in. One thing is clear, however: the ECB is taking
on a more dovish stance by expanding its non-standard policy easing
toolbox, and has no intention of tightening policy within the next 12-
to 18-months.
The ECB’s ‘lower for longer’ stance is prohibitive for the Euro
because the British Pound and the US Dollar are being bombarded with
strong economic data and rising sovereign yields as a result, as market
participants start to price in interest rate hikes from the Bank of
England and the Federal Reserve, respectively.
In this interim period of ECB inaction, we turn our attention outwardly to the BoE and the Fed as the more significant drivers of price action in EURGBP and EURUSD (and
GBPCHF and USDCHF as well, given the highly significant, nearly perfect
positive correlation between EUR and CHF since September 2011 when the
SNB levied the Sf1.2000 floor in EURCHF).
