Euro Chopped Lower Before Stabilizing

Euro closeup on ECB Abbreviation

  • The euro has stabilized after extending yesterday’s ECB-driven losses; investors continue to digest the announcements made by the ECB yesterday
  • Four economic reports fill the news stream: China inflation, France IP, German trade, and UK trade
  • The North American session will not be bolstered by much data
  • Curve steepening in the Eurozone after the ECB adds to the negative backdrop for EM
  • Korea’s parliament voted 234-56 to impeach President Park
  • South Africa Q3 current account deficit came in at -4.1% of GDP; Brazil inflation eased

The dollar is mostly firmer against the majors in the wake of the ECB decision. The Aussie and sterling are outperforming, while the yen and the Norwegian krone are underperforming. EM currencies are mostly weaker. RUB, CZK, and MYR are outperforming, while TRY, KRW, and MXN are underperforming. MSCI Asia Pacific was up 0.1%, with the Nikkei rising 1.2%. MSCI EM is down 0.3%, even with Chinese markets rising 0.7%. Euro Stoxx 600 is up 0.4% near midday, while S&P futures are pointing to a higher open. The 10-year UST yield is up 3 bp at 2.43%. Commodity prices are mixed, with WTI oil up nearly 1%, copper up 0.8%, and gold down 0.2%.

The euro has stabilized after extending yesterday’s ECB-driven losses. The euro’s drop yesterday was the largest since the UK referendum to leave the EU. Ahead of the weekend, there may be some room for additional corrective upticks, but they will likely be limited, with the $1.0650 area offering initial resistance. In the larger picture, this week’s range, roughly $1.05 to $1.0850, likely will confine the price action for the remainder of the month. Of course, thin holiday markets (after FOMC next week) could make for erratic price action.

The German two-year yield is a few basis points from the record low seen in late November. The US premium is at the high for the week and less than two basis points below the extreme in 16 years. Next week, the FOMC meets, and while a rate hike has been discounted, growth and inflation forecasts may be lifted. The recent Wall Street Journal survey of economists found the majority expected three hikes next year.

Investors continued to digest the ECB’s announcements yesterday. Following the Federal Reserve, tapering is meant to imply a slowing of purchases toward an ending of them. What the ECB announced yesterday was most definitely not that. In fact, the asset purchases seem to be quite open-ended. Consider that the staff forecast of 1.7% for 2019 inflation was rejected by Draghi as insufficient to discharge the ECB’s duty. Draghi repeatedly and vociferously denied the ECB was tapering.

The reduction of the monthly purchases could reflect at least two forces. First, it could have been a small price to get some of the creditors, like Germany, to go along. This is desirable even if not necessary. It does not give up much. In fact, the ECB will buy 540 bln euro of bonds instead of the 480 bln the market had expected (9*60 > 6*80). By the end of next year, the ECB’s balance sheet will be about 40% of GDP. Second, by reducing the amount, the ECB could help alleviate some shortage pressure.

Long rates rose in Europe yesterday and are higher today. Some are arguing that buying 20 bln less a month is a material force. At the same time, the rules were adjusted that allowed the ECB to buy bonds with yields lower than the deposit rate. That means that the short end of the curves may find a better bid. Today, two-year peripheral yields are lower while rates in the core are slightly firmer.

The rising yields and equity markets weighed on the yen. The dollar is at its best level since the start of the week. Resistance is seen near JPY115.00. Today could be the first session the dollar has spent entirely above JPY114 since February.

The major currencies are quiet, though the Canadian dollar is interesting. It is edging through yesterday’s highs. In fact, the US dollar fallen against the Canadian dollar in six of the past seven sessions. The recovery in oil prices and cross rate gains may have driven it. There is scope for additional US dollar slippage, but we suspect it will be limited initially to CAD1.3160. A trend line connecting the May, August, and September lows comes in near CAD1.31. The currency-sensitive two-year interest rate differential is moving back in the US direction.

Four economic reports fill the news stream today. First, China’s inflation rose. Headline CPI rose to 2.3% from 2.1%. Producer prices jumped more. They are up 3.3% from a year ago to stand at a five-year high. In October, it was at 1.2%. Remember that until September producer prices had been falling since March 2012 on a year-over-year basis.

Second, France, like Germany earlier this week, reported disappointing industrial output figures for October. Output had been expected to rise around 0.5%, but instead fell 0.2%. Adding insult to injury, the September series was revised lower (-1.4% from -1.1%). Manufacturing was also a big disappointment fall 0.6% instead of rising by as much. The September figure was also revised down. The aggregate figure will be released next week. There is downside risk to the median guesstimate of 0.2%.

Third, Germany reported a smaller than expected trade surplus of 19.3 bln in October. Exports rose 0.5%, which represents a smaller recovery from the 1.0% revised decline in September (from -0.7%). Exports have risen 3% over the first 10 months of the year. Imports rose 1.3%, a little more than expected. The current account surplus was also a little smaller than expected.

Fourth, the UK reported smaller trade and current account balances in October. The September figures were revised to show larger shortfalls, so the October improvement is more dramatic. The overall trade deficit narrowed to GBP1.97 bln, which is the smallest in five months. It is a third of the size of the September deficit that was revised to GBP5.81 bln (revised from GBP5.22 bln).

In other market developments, Asian markets rallied following the new record equity levels in the US. The MSCI Asia-Pacific Index rose almost 0.2%, for the fourth consecutive gain. It is up 2.3% on the week. The Nikkei rose 3.1% this week and has gained in all but two weeks since the start of Q4. The Dow Jones Stoxx 600 is rising for the fifth session. It is up nearly 4% this week. Today’s gains are sufficient to fill the gap created in early January. However, some profit-taking is being seen in Italy, Spain, and Germany. Italian bank shares are off nearly 3% to snap a three-day advance. An announcement is expected either over the weekend or early next week about who will lead the next Italian government. Don’t be surprised if it is Renzi.

The North American session will not be bolstered by much data. The wholesale inventories may impact GDP forecasts, while the University of Michigan survey has little but headline risk.

After the ECB meeting, we have seen curve steepening in the Eurozone. This is on top of curve steepening in the US seen since the elections. While we are nowhere near the magnitude of the 2013 Taper Tantrum, these yield curve dynamics remain negative for EM bonds and EM FX. EM equities are a different matter, supported in part by the continued post-election rally in DM equity markets.

Korea’s parliament voted 234-56 to impeach President Park. Popular protests were simply too big to ignore, as dozens of members of her own Saenuri Party voted to impeach. Prime Minister Hwang assumes temporary power until the Constitutional Court upholds the impeachment or Park resigns. Then, a new presidential election will be held. Opposition and non-traditional outsiders critical of corruption and ties between the chaebol and politicians are likely to be favored in the race. While KRW weakened today in line with EM, we think political developments are a long-run positive for Korea.

South Africa Q3 current account deficit came in at -4.1% of GDP vs. -3.6% expected. A wider deficit despite sluggish growth is negative for the rand. South Africa sees very little FDI, relying instead on so-called hot money to finance its current account gap. A wider gap comes at a time when EM is struggling to attract investment inflows, and South Africa remains one of the most vulnerable.

Brazil November IPCA inflation came in at 6.99% y/y vs. 7.08% expected. This was the lowest since December 2014. Yet COPOM was cautious last week and cut rates 25 bp to 13.75%, as expected. However, it raised the possibility of a faster easing cycle if the economic recovery remains elusive. Next policy meeting is January 11. We think the choice of a 25 or 50 bp cut then will depend in large part on BRL and the external environment, as disinflation may slow due to the weaker currency.