The Euro tumbled to its lowest intra-day level since 2006 at the market’s open last night, however, since then it has managed to stabilise. The decline is down to three factors:
- Draghi, who had been chartering about the prospect of more action from the ECB in the coming weeks (the next meeting is the 22nd Jan),
- Expectations of weak inflation data due out this week, and
- Start of Greece’s political campaign ahead of elections on the 25th Jan.
Draghi tries to woe the Germans
If Draghi thought that spacing out the ECB meetings was a way to reduce volatility, he was very much mistaken. By have meetings every six weeks, compared to previously every four weeks, means that we have two more weeks to speculate and read into every word spoken by the ECB’s Governing Council.
Draghi’s interview to a German paper on 2nd January included two important statements from Draghi: Firstly, he said that the risk to the German taxpayer is lower now than earlier in the Eurozone crisis, and secondly, he disagreed with the interviewer, and said that the head of the Bundesbank, Jens Weidmann, does not disagree with Draghi over purchasing government bonds.
Draghi was talking to a German newspaper so he is trying to show his interests are aligned with German interests, which is important if the ECB is to take more radical action at its next meeting. We are still not 100% sure that the ECB will embark on full blown, Fed-style QE at its next meeting, but for now the market is happy to run with this theme.
Inflation data calls for action
The economic data has also played into the hands of the EUR bears. German inflation for December, released today, showed that 4 out of 5 regions reported weaker than expected prices for last month, only Saxony bucked this trend. What is more surprising is that some of the misses were large, with annual Bavarian inflation data falling to a 6 year low. On Wednesday we get the December CPI estimate for the entire currency bloc, and the market is expecting a fall into deflation for the first time since 2009. The risk is that the drop is larger than the -0.1% expected.
The FX impact
EURUSD is stabilising around the 1.1950 mark in the mid-morning, after dropping to a 2006 low of 1.1875 overnight. While we still think there could be further weakeness, the fact that most of the market are looking for further losses makes me pause.
In the next few days it could be a case of sell rallies back to 1.20 rather than initiate new shorts on any losses, which would indicate that we could be in for a period of consolidation until we hear something else from the ECB. However, in the longer-term we could see back to 1.15 by the time the year is out.
But what about Greece?
What I find interesting about this EUR move is that it doesn’t seem to be driven by Grexit fears. At the weekend the leader of the Greek opposition, Syriza, said that his party would end German-led austerity if it wins the poll on the 25th. This would cause a default and Greece’s exit from the Euro-region. The EUR may have fallen 3% since before Christmas, however, only a couple of years ago the prospect of Greek exit could have triggered a 10% decline.
Has the market got used to the idea of Greece being out of the currency bloc? Maybe, the German press reported at the weekend that German Chancellor Merkel is ready to accept a Greek exit and sees it as both manageable and inevitable if Syrizia wins the election later this month.
If Merkel remains calm, could the market? Just because Greece leaves doesn’t necessarily mean that the EUR needs to disband. However, if Greece thrives in the years after a Grexit, that is when the real problems could start for the Eurozone, with more members queuing up to leave sending the EUR into free-fall.
For now, the EUR is falling on the back of QE expectations, which may never materialise. Although Greek bond yields are rising as the EUR falls, the decline in EURUSD in recent weeks seems tame compared with the 17% rise in the 10-year Greek yield. Thus, maybe the EUR could survive a Grexit, after all.
Figure 1:
Source: Please note this is a bloomberg chart and does not reflect the prices offered by FOREX.com
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