Divergence still on track – despite ECB disappointment
Given the unwieldy nature of European politics, the European Central Bank often under-delivers at crucial moments as it did last week setting the scene for the third largest ever move in EUR/USD.
Nonetheless, the divergence trend remains intact, it’s just that it hasn’t smoothly followed the script market participants had anticipated. All the dynamics for divergence remain in place for it to continue in the short- to medium-term.
Despite cutting one of its key rates further into negative territory and extending its quantitative easing programme – EUR/USD plunged by just over 4% as the ECB didn’t go as far as the markets had expected. The lack of policy ‘shock and awe’ reflects divisions on the ECB’s board.
However, Mario Draghi, the ECB’s President, is a big fan of verbal intervention no doubt reflecting his frustrations with often not getting his own way in terms policy, at least in the short-term. The very next day in New York he delivered an extraordinary speech where he talked of his own control over policy, claimed the central bank could expand its balance sheet without limit and talked of monetary dominance – sounding very much like a call of ‘doing whatever it takes’ to defeat the gathering forces of deflation bedevilling the Eurozone.
But for all the hubris, Draghi clearly faces opposition towards ratcheting up quantitative easing, not least from the powerful German contingent on the board who view such tools with deep suspicion. Events in the commodities markets where oil took another hammering due to over-supply will deliver more deflationary pressure on the Eurozone and ammunition for Draghi to win the day over more monetary stimulus. But it will clearly take some time for him to get his way.
Next week it’s the US’s turn to deliver
Meanwhile, US Non-Farm Payroll numbers came in at a reassuring 211,000 for November making an interest rate increase by the US Federal Reserve all but a done deal for next week. It would take something like a stock market crash or other ‘black swan’ event to derail that. Interestingly, Fed Chairwoman, Janet Yellen talked of the US economy only needing 100,000 jobs a month to be created to absorb new entrants to the jobs market. It has been running at double that on average this year.
She also said further delays in raising rates could lead to needing to increase rates even faster latter on. Indeed, if jobs creation does average over a 100,000 a month over 2016, it’s quite possible that US rates could be raised several times to reach 1.00-1.50% by this time next year. With the ECB under Draghi looking to increase its monetary stimulus, the path of divergence remains on track for the time being.
But as last week showed it only takes small deviations from the markets’ script to set-up some almighty moves. Factors, which could shatter expectations on US rates are nervous equity markets, increasing geopolitical instability, growing deflationary pressures and disappointment on global / US economic growth. They could all weigh on US interest rate expectations creating a risk that the US convergences towards rather than diverges away from other large troubled economies such as the Eurozone, Japan and China and that would certainly take the wind out of USD’s sales.
TECHNICAL ANALYSIS: EUR/USD – battered & bruised shorts may not return for a while
Last week, EURUSD short sellers had their heads handed to them on a plate as the ECB underwhelmed on its monetary stimulus. After such a strident set-back it will take considerable bravery for EUR short sellers to return i.e. they’ll need a very good reason, such as an important catalyst.
From a fundamentals perspective, the gravitational pull towards parity remains in place, but from a technicals point of view the picture is mixed. Indeed, even if the Fed pushes ahead with its very widely anticipated 0.25 rate rise next week losses on EUR/USD may only be limited as badly scarred short-sellers will be weary of getting back into the fray. The catalyst short sellers will be looking for is what’s likely to happen next and when i.e. the next timing and scope of future rate rises. Therefore, it may require a hawkish statement from the Fed – not expected – to really move the dial on EUR/USD on the downside.
Among the important resistance levels potentially hindering upside progress are 1.0981, 1.1095 and 1.1108 with support placed around 1.0830 and 1.07959. On the upside the MACD still has a strong buy signal for EUR/USD and the pair are forming a potentially bullish short-term consolidation pattern. But on a longer-term basis the overall trend still looks downward for EUR/USD, but as 2015 has showed, on three occasions now, that even reaching parity, never mind breaching it, is a tough call.
By Justin Pugsley, Markets Analyst, MahiFX