Having seen the single currency hit the $1.2000 level for the first time since the beginning of 2015 earlier this week, speculation has continued to rise that European Central Bank officials could try and jawbone expectations around monetary policy in an attempt to slow down the precipitous rise that has taken place since the French elections in mid-May, when it was trading around the $1.1200 level.
Much of the focus year-to-date has been on the rise of 14% against the US dollar, though we’ve also seen strong gains against the Japanese yen, the Chinese yuan and the UK pound of between 6% and 8% which is bound to have a significant effect on European companies export performance in the coming months.
Part of the outperformance against the US dollar has come about as a result of the collapse of the Trump trade since the beginning of the year, which may have contributed to a slight overshoot as markets start to price in the prospect of a tapering in the European Central Bank’s bond buying program at the beginning of next year, while at the same time dialling back on US rate hike expectations.
The improvement in European economic data over the past few months has helped support this expectation of a tightening bias with the only unknown being how much and how gradually the ECB will ease up on its easing program. There is a danger that the markets may be overestimating the speed with which the ECB could look to dial back its asset purchase program, particularly with an Italian election in the offing in early 2018.
It is true that markets took the reluctance of ECB President Draghi’s reluctance to comment on the value of the euro at Jackson Hole as a tacit admission that he was unconcerned about its recent rise, however with a meeting due next week he could merely have been biding his time.
In any case it would be a surprise if we got that much more detail on the ECB’s plans for next year ahead of the German elections which take place towards the end of September.
There is also the prospect that markets may also be underestimating the performance of the US economy, which has not only seen a significant upward revision to Q2 GDP to 3%, but also evidence of a labour market that appears to still be generating a decent number of jobs, with the latest ADP payrolls for August adding 237k new roles with a revised 201k being added in July.
The failure to hold above 1.2000 earlier this week could well be an early indication that the current euro rally needs to pause for breath, with a concerted break below 1.1900 arguing for a deeper correction, back towards 1.1600.
The current price action does appear to point to some exhaustion in terms of positioning, and a failure to recover 1.2000 could well see this unfold as we head towards next week’s ECB rate meeting.
If Friday’s US payrolls report also paints a similarly rosy picture as today’s ADP data, and more importantly the wages numbers start to show evidence of inflationary pressures then the decline that we’ve seen in the US dollar index over the last six months could reverse itself quite quickly.
Currently US rate hike expectations are priced at 33% for a move in December, which seems rather low at this point in time. There is also the prospect that for all President Trump’s flaws and the upcoming battle over the debt ceiling that Hurricane Harvey could offer the Republicans a quick win in terms of avoiding a confrontation there as well as agreeing a fiscal stimulus plan, which would also play well not only to the party’s key support base but across the country as a whole.
It is quite apparent that the heavy damage that has been wrought on Louisiana and Texas will require significant Federal funds to help clear up, as well as repair the damage, which if played correctly could give Trump a political victory of the type that his Presidency has been lacking thus far.
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