Market News & Insights
26 October 2017

Downside Favored For Euro Risk

GBP rallied over 1% yesterday as GDP figures pointed to growth of .4% through Q3, better than the .3% expected. It was a slow rally for the pound as it gathered momentum through the morning as demand grew, with markets now eyeing next week’s BOE meeting and the prospect of Carney raising interest rates. The bigger picture remains unchanged for the UK however with annual growth expected to come in at 1.5%, one of the slowest of OECD countries. The Euro was firmer elsewhere in trade yesterday, advancing against the USD, JPY and CHF amongst others. All eyes will be on today’s ECB meeting and the eagerly awaited details of how the governing council intend on exiting their QE program.  The dollar also found itself under some selling pressures, a combination of concerns on Trumps tax plan not getting approval in the house and some weaker earning results saw the greenback slip from near 3 month highs, even despite some better than expected data with durable goods orders up 2.2% vs the 1% growth expected. It was a mixed bag in stock markets with European indices trading relatively flat ahead of today’s ECB meeting, while in the US some poor earnings results weighed on indices, however some losses were covered into the close of the session.

There will be no avoiding ECB headlines today in what has been a long and highly anticipated wait to see what plans the ECB will be putting in place once the current asset purchase program expires in December. It has been taken for granted that the ECB will be extending QE into 2018, and despite the additional easing next year the Euro has rallied through 2017 on expectations the ECB will be tapering the purchases, eventually winding down QE, which then opens the door to interest rate hikes. We have been of the view the market has been getting a little ahead of itself, and while the Eurozone economy is certainly in a far stronger position that when he took over, Mario Draghi will be conscious of not undoing his good work by raising interest rates too soon, and repeating his predecessors mistakes. Market expectations are for a cut from €60bln to €30bln in purchases per month, out to September. The next favoured levels is €40bln out 6 months. This is our base case and anything between €240bln up to €270 bln should see the Euro find some slight support.  However for us the risks to the euro are to the downside, and should Draghi fail to live up to the markets hawkish expectations then the Euro has considerable room to the downside. Any purchases in excess of €270bln next year, or indication purchases will continue beyond September will push out expectations for rate hikes and thus initiate euro selling. Markets do not see any rate hikes until at least the first half of 2019 and beyond Draghi’s term as president, so we’ll be closely watching front end rates for any signs of changes. Another area of interest is the possibility the ECB will look to re-invest the maturing bonds they’ve purchased, which estimates approx €15bln per month in purchases. Again this area has not been priced for markets and should we see this in addition to any announcement then there is once again a risk of euro selling.

There are other areas the ECB will be watching, the rally higher in the Euro has a disinflationary impact for the region and the ECB will certainly be conscious of the value of the single currency impacting their inflation target, which sits just below 2%.  For us there are far more downside risks for the single currency and while the anything in line with expectations should see some slight Euro strength, the risk is heavy Euro selling should the ECB fail deliver in line with expectations. EURUSD still holding its range, 1.1700/1.1725 area provides support, while rallies higher find sellers from 1.1850 all the way up to 1.1900. A break below 1.1725 likely targets recent lows just above 1.1660, should that level break we can expect larger declines to come, potentially as low at 1.1480 in coming weeks. A break above 1.1900 will favour recent highs towards 1.2100 but any gains are expected to be limited once we rise above 1.2000.  EURGBP range now looking like .9030 to the topside and .8850 to the downside provides support. A breakout is required for any continuation.

We will have some US data crossing the wires just when Mario Draghi is due to take the stage at 1.30pm, with the trade balance expected to show a $64 bln deficit. The dollar has been trying to press higher but in the shorter term it feels like the greenback is more exposed politically, with USD appearing to be driven by the success (or failure) of Trumps tax plans. Pressure is on the GOP to approve the plans and once again they are facing criticism, with Trump publically starting public arguments on certain senators, accusing them of blocking the plans. To be fair, the argument is once again that Trump has provided a wish list of a proposal  which he has just passed down to the house, and it’s up to them to figure out how it will actually work and to get it passed.  And like the healthcare act before it, there are many holes in the plans and as a result congress appears very hesitant to pass. GBPUSD is looking higher after breaking above 1.3230 yesterday, this area provides light support for now and upside will be looking at some resistance towards 1.3335/40.