Week in FX Europe – EUR Run Ragged after Consolidation

Diverging monetary policies have fueled the U.S. dollar's strength this summer, more so against the EUR than any of the other Group of Seven (G-7) currencies. On Thursday, the pressure applied to the single unit managed to push it to its weakest outright level (€1.2697) in almost two years. To date, the greenback has ridden the wave of quantitative easing (QE) tapering and the prospect of a mid-2015 rate hike, and because of that, the market has been able to ride the telegraphed last five-cent EUR freefall with very little obstruction.

Are Unorthodox Monetary Measures Afoot in the Eurozone?

Over the past week, aiding the EUR's demise was the European Central Bank (ECB) President Mario Draghi reiterating that eurozone policymakers could use additional unconventional policy measures if it felt that its inflation target was threatened. But further dollar strength will need to be derived from how the Federal Reserve manages its balance sheet, and it's here that opinions begin to split. Currently, the Fed has all the tools it needs to raise borrowing costs when it decides the U.S. economy is strong enough to take it, and we can expect them to keep adjusting its policy as it exits the current stimulus program.

The expected breadth and depth of the EUR's downtrend varies from dealer to dealer, ranging from €1.17 to €1.22 over the next six months, solely on expectations that the ECB will have to implement QE to bolster inflation. This week, Draghi again maintained ECB policy would remain accommodative for the foreseeable future. However, he also stressed that he did not see inflation risks in the eurozone — he sees risks to low inflation for a “long time.” Draghi's tone has many wondering whether full-blown QE might be on the cards. The ECB has already pledged to buy some types of nongovernment bonds, and an extension into euro sovereign debt seems to be the next reasonable step.

Draghi's German Conundrum

In reality, many questions do remain, not least around the mechanism that the ECB could use given German legal obstacles. Like most G-7 central banks, the ECB could provide unlimited amount of capital or credit, but if the fiscal and structural set up hurts rather than aids the region, what's the point?

With risk assets in freefall yesterday across the various asset classes, there is no bigger safe haven for investors than the mighty U.S. dollar. The EUR's big move lower has followed 10 days of consolidation, and the next target for the techies is the November 2012 low of €1.266. With the market predominately short the single unit, next week's ECB post-rate setting press conference will set the tone for the EUR's next directional leg.

What to Expect Next Week

Europe will kickstart next week's trading activity with German preliminary inflation numbers. It will be an all-day event on Monday because the ‘actual' is comprised of data from six German states, which report their consumer-price indexes throughout the day. Both China and the U.K. will deliver manufacturing purchasing managers' indexes by midweek, just after the market gets to gauge consumer confidence in the U.S.

The ECB monetary policy meeting will dominate activity on Thursday. The rate decision is often priced in to the market, so expect it to be overshadowed by the ECB's post-meeting press conference.

Down Under, New Zealand's monthly ANZ Business Outlook survey will be out on Monday. It's a leading indicator of that country's economic health. It's worthwhile to note the Kiwis' business confidence numbers have been on a downward trend over the last six months. Business sentiment is usually an early signal of future economic activity such as spending, hiring, and investment. Not to be left out, the Aussie's monthly retails sales are reported on Tuesday, a day before building approvals and trade numbers.

The granddaddy of economic releases – the U.S. nonfarm payrolls (NFP) report – will close out the week. The NFP's importance usually makes for a hefty market impact. Also, Canada will produce its gross domestic product numbers in the first half of the week, while Canadian trade balance data will follow the U.S.'s own trade numbers release on Friday.

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