Over the past week, foreign exchange markets have been offered opposing views on the next play in European and American monetary policy. The differences are wider than the Atlantic Ocean.
In Europe, the Bank of England (BOE) faces many problems as the falling level of Sterling threatens to ignite inflation from its current 1.0% at a time when the economy is struggling to accommodate the uncertainty over the terms of Brexit.
A larger dilemma faces the European Central Bank (ECB). With a tepid economy, GDP growth just 0.3% and unemployment of 10.1% coupled to a fragile banking system it is obliged to hold open the door for further monetary stimulus in December and maintain that accommodation deep into 2017.
In stark contrast the district Federal Reserve Banks and Federal Reserve have delivered a relatively positive economic outlook.
Economic growth in the US is running at clip of 1.4% and national unemployment is steady at 5.0%. Economic optimism is at the best level in 19 months…not so shabby given the uncertainty that usually arises in the last months before a Presidential election without the incumbent seeking re-election.
Stark difference
The tone from the Federal Reserve has adopted an increasingly hawkish tenor in the past month and stands in sharp contrast to the softer, more conciliatory rhetoric that has poured forth from the other leading central banks.
To that note the gains of the Dollar in the past month are…
USD versus: AUD 0.35% CAD 1.95% CHF 2.08% EUR 2.79% JPY 3.49% and GBP 6.55%
Euro under pressure
The Euro may not have been the weakest pair currency against the Dollar in the past month or even past week, it has, however, fallen to its weakest level against the US unit in nearly 7 months. It closed on Friday at 1.0882, down 0.42% on the day.
The European single currency has been in retreat even though the apparent capitulation came after the ECB governing council meeting last Thursday, October 20 in Frankfurt.
Markets were somewhat caught on the hop by the rapidity of the move lower as on Thursday there was no discussion re extending the quantitative easing programme or further rate cuts. EURUSD fell 0.40% on Thursday and by 0,.42% on Friday.
President Draghi did discuss the impact of negative interest rates and was clearly frustrated by the scarcity of assets available within the locus of acceptable bonds his for the asset purchase scheme. There were, however, no decisions on expanding the pool of available assets or enlarging the scale purchases at this time. This was not well received in Greece as Draghi said it was premature to contemplate Greece being included in the bank’s asset purchase programme before its debt is made sustainable.
So, to be frank there was nothing that could have been interpreted as remotely immediately dovish in Draghi’s comments. It would appear that it was the prospect that the ECB will unveil plans to extend its quantitative easing measures at its December meeting and the absence of any upbeat commentary on economic positives re the Eurozone that catalyzed investors to drive the Euro lower.
Near a bottom? No many dangers still lay in wait.
A good number of market commentators are quick to suggest that EURUSD will establish a base at 1.0800 before foraging back toward 1.100. This is a very short-term outlook as they point to upcoming data in the week ahead.
At the start of the week, Eurozone PMIs (manufacturing, services and composite) and the German IFO reports are scheduled for release. These may be slightly elevated compared to the last reading although I do not see why Sterling’s weakness would boost the Eurozone’s industrial prospects. The Eurozone does send 17% of its exports to the US, however, EURUSD weakness would not have filtered through to those numbers for release this week.
President Draghi will also be speaking in public over the week so investors will undoubtedly be on the lookout for any fresh insight into the ECB’s monetary policy plans for the end of the year that he neglected to mention last week.
I am no day trader and I am more inclined to consider the state of the body politic in the four leading economies of the Eurozone for reasons why a strategic trade will expect that the Euro will remain under pressure throughout next year.
In Italy, this December will see a referendum on reform. If defeated it would lead to the resignation of Matteo Renzi, the Prime Minister. This would suggest a new general election where Movement Five Star could well capitalise on its recent local election success. This would throw Italy into chaos.
In April the first round of Presidential elections in France may well see the leader of the Front National, Marine Le Pen placed first, although she would lose the second and final runoff round...most likely against either former President, Nicolas Sarkozy or former Prime Minister Alain Juppé from Les Republicans.
Spain has had two indecisive general elections in December 2015 and June 2016. The People’s Party remain the largest single political presence in the Cortez, however, government in Spain is on the basis of “Supply and Confidence”. This does not allow any clear or coherent political and economic strategy to be developed.
Then toward the end of 2017 in October there will be a general election in Germany. The rise of the Alternative Für Deutschland has the potential to pose a serious threat to the majority of the Christian Democrats of Angela Merkel. The election may lead to another Grand Coalition, however, there is a strong prospect of Germany being led by Sigmar Gabriel of the Social Democrats and so leaning slightly left of centre.
The Greek issue has never gone away and for now it is just simmering in the background. However, before long it will come to the boil once more especially as just last Thursday the German Finance Minister Wolfgang Schäuble said debt-ridden Greece needed a deeper economic overhaul, not debt relief. This is because any easing of the debt burden would reduce the urgently needed willingness to reform the country. An area where since 2009 Greece has been far too slow to act. So still the most powerful Eurozone economy and effective paymasters is at odds with the International Monetary Fund who are unwilling to extend further assistance unless Greece is released from some of its crippling debt burden of 177% to GDP.
Dealing with the outside world
The issue of Brexit is going to be in the minds of forex traders until March 31 2019 when one would hope the process of Article 50 by which the UK leaves the European Union (EU) is concluded.
Of a more immediate concern is that the EU and this will impact the Eurozone and Euro is finding it hard to negotiate trade deals when so many voices have to be heard and one small region of a small nation can block a wide ranging trade agreement.
A trade deal between the EU and Canada, the Comprehensive Economic and Trade Agreement (CETA), is likely to collapse because the Belgian region of Wallonia with a population of just 3.6 million opposes it on fears on imported Canadian milk harming local farmers.
The Canadian Trade Minister Chrystia Freeland left the talks in Brussels, clearly frustrated saying the EU was "not capable" of signing a trade agreement.
The wide-ranging deal, seven years in the making, was to be signed next week. If enacted, the agreement would eliminate 98% of the tariffs between Canada and the EU. Macroeconomic modelling suggested that both the EU and Canada would have enjoyed a boost to real GDP growth, the EU by 0.02–0.03% and Canada by 0.18–0.36%. That does seem at first glance a little lopsided, however, on must recall that approximately 65% of EU member states export/import trade occurs within the EU as “intra-trade”.
I have little faith that the Euro, as the currency that 18 of the EU nations use is going to be in a position to make much headway on a consistent basis against the Dollar. I am not talking about small day to day jumps. There will always be bouts of profit taking as traders cover short positions in the Euro. Overall, with political issues a plenty over the next 14 months and an anaemic economy and weak banking system that has never been adequately held to account and which appears incapable of financing lethargic commerce I remain convinced that EURUSD parity is a serious probability in the course of 2017.
Stephen Pope ~ MarketMind
