Will Draghi make good on policy easing promise (threat)?

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The big story this week has been the continued reversals in EUR$ & GBPUSD (Cable), both pairs extending declines after touching multi-year highs in early May.

It seems that sentiment now versus that of a month ago has drastically shifted away from both Sterling & Euro.

After taking a run at 1.7000 Cable has given back 300-pips; breaking through key trend support going back to August 2013 in the process. This is a strong bearish signal and suggests that we may have already seen the top of near term trading activity for this pair. This pair has rallied over 20 big figures from 1.4800 in the last year or so. Hence, it’s a reasonable hypothesis that the value of current British economic expectations versus those of the United States are now priced in. Looking forward, there is still a strong justification for this pair to continue to trade in the mid and upper 1.60’s given that the Bank of England is still widely expected to hike interest rates before the Federal Reserve, even if only by a few months. As such trading for GBPUSD could move into a sideways trend over the coming months.

In early May European Central Bank (ECB) president Mario Draghi mentioned “serious concern” about the impact of a strong Euro on inflation prospects and that because of that relationship “the governing council is comfortable with acting next time [June]”. This has put the common currency on its back foot over the last few weeks, particularly against the US Dollar. Just before the announcement EUR$ touched multi-year highs as it mounted an assault on 1.4000. A mere 3 weeks later EUR$ tumbled 400-pips to its lowest level since February 2014 as investors price in the possibility that Draghi will make good on his warnings. Ahead of next Thursday’s ECB policy announcement the common currency is likely to remain soft, however its performance afterwards is undoubtedly contingent on Draghi’s actions.

After a couple of light data weeks, the coming week’s calendar has lots of events to be conscious of. There are a string of Purchasing Manager Index (PMI) releases out of the UK early in the week, plus EU inflation and unemployment numbers. However the headline events are the European Central Bank (ECB) policy announcement and American unemployment statistics. All of these events could be market moving. Given the negative sentiment in both Euro and Sterling over the last couple of weeks, misses could result in aggravated losses relative to gains should the results be better than expected.

Along with the above mentioned events there is also a Bank of England (BoE) monetary policy announcement. Normally this event would rank quite highly. However despite encouraging economic trends and calls for rate hikes to combat a bubble-ish looking housing market, the likelihood of tighter policies being announced next week appear negligible. BoE Governor Carney has been clear that economic slack remains a concern and that he feels that the UK economy does not yet have enough momentum to sustain itself in an environment of higher interest rates. As such the BoE policy announcement on Thursday is looking like it could be a non-event.

It’s American Non-Farm Payrolls (NFP) & Unemployment Rate this Friday. This twin release is perhaps the single most important data event of the month. Last month’s posted its strongest result in nearly 4-years at +288k. This helped drive the unemployment rate in the world’s largest economy down to 6.3%, its lowest level since October 2008. In turn this has put pressure on US Federal Reserve (Fed) Chair Janet Yellen to tighten the purse strings. While a strong result on Friday would see additional pressure on the Fed, Yellen doesn’t look to have any interest in moving the schedule for tighter monetary policy forward from current expectations of early 2015. Previously Fed forward guidance involved an unemployment threshold at 6.5%, which has now been breached. However similar to the BoE, the Fed got cold feet and it recently revised its flagship policy. New Fed guidance is now a sufficiently vague declaration (with references to the labour market and inflation) to provide Yellen the flexibility to leave policy as is until she sees fit to change it.

Following rather explicit threats at last month’s ECB policy announcement that elevated Euro values could trigger fresh monetary policy easing, there is a high degree of anticipation for Thursday’s ECB policy announcement. Whether declines in the last few weeks have been sufficient to pacify the ECB however is unclear, and based on sentiment, likely not. As such there is a degree of uncertainty heading into Thursday’s announcement, which elevates the likelihood of rate volatility.

Further reading: 3 ways central banks can move markets

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About Author

David Starkey is a currency options dealer and market analyst for Cambridge Mercantile Group. A fascination with the everyday impact of globalization on society led David to pursue a degree in International Business from the University of Victoria. From there Forex was a natural fit. He has worked as a currency trader, risk manager, and hedging expert in both Canada as well as the United States for several non-bank brokers. Cambridge Mercantile Group.

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