Rational FX

Wednesday 09th December 2015 06:48 EST

It has been an interesting week for the Euro to say the least. Mario Draghi shocked markets last week with the Euro gaining significantly against its major peers after the European Central Bank (ECB) monetary policy meeting last Thursday. Draghi announced that the ECB was going to cut its deposit rate from -0.2% to -0.3% - although markets were expecting to see a more drastic cut at around -0.2%. In addition, asset purchasing is to remain at 60 billion a month – again, markets were expecting this to be expanded. However, quantitative easing (QE) will be extended to the new maturity date of March 2017 – a 360 billion increase. Interestingly, Draghi mentioned that the asset purchasing will be reviewed in the spring time which gives a sense of flexibility to the program. The result of this announcement was that the Euro rallied against both greenback and cable - Euro gained 2% against the dollar and 1.75% against sterling.

 The most logical explanation for this seems to be that markets had priced in more drastic measures such as harder deposit rate cuts and an expansion of QE rather than just an extension. Given that this was not delivered, the ECB seems to have shown that the outlook for Euro was better than expected and markets reacted accordingly to this.

In spite of this, the divergence in monetary policy of the European Central Bank and the Federal Reserve does give strong credence to the long term view that EUR/USD will depreciate. This is compounded by the Fed looking very likely to increase interest rates on the 16th December.

Data on sterling has been relatively quiet over the last week. Worthy of note is that lending to consumers rose by £1.2billion last month - up 8.2 per cent compared with October last year. This has prompted some concerns about people's reliance on personal loans, overdrafts and credit cards in order to make ends meet.

In addition, PMI figures showed growth in Britain’s manufacturing sector has weakened and costs are falling sharply, suggesting Bank of England policymakers are unlikely to be in a rush to raise interest rates this Thursday. Bank of England governor Mark Carney has suggested that the decision about rate rises is likely to “come into sharper relief around the turn of this year;” but continued deflation across industry is likely to undermine the arguments for an increase in borrowing costs at next week’s monetary policy committee meeting, the last of 2015.

Further, we saw the pound weaken after market research firm Markit and the Chartered Institute of Purchasing & Supply said that their U.K. construction PMI declined to a seven-month low of 55.3 last month from a reading of 58.8 in October. It was expected to fall to 58.2 in November. It signaled the slowest expansion of business activity for seven months. This saw sterling fall almost a third of a percent against the dollar and added to a sense that the British economy is struggling to deliver the sort of sustained demand pressure that may prompt the Bank of England to raise interest rates.

On the dollar front, the forces of a strong dollar, weak oil prices and tepid global demand sent the Chicago PMI lower - its sixth contraction of the year. 

Manufacturing in the U.S. unexpectedly contracted in November at the fastest pace since the last recession as elevated inventories led to cutbacks in orders and production. The Institute for Supply Management’s index dropped to 48.6, the lowest level since June 2009, from 50.1 in October. Federal Reserve policy makers will take the manufacturing data into consideration as they debate whether the economy is strong enough to withstand a tighter monetary policy this month. The Federal Open Market Committee meets December 15-16 and is expected to raise their benchmark interest rate by 0.25 percentage point.

In addition, the U.S released strong employment which further increases the chances that the Federal Reserve will raise interest rates. A total of 217,000 new jobs were created by US companies last month. This is the biggest rise in private sector payrolls since June, and beats forecasts for a 190,000 increase. It also beat October’s reading of 196,000, which was revised up from 182,000. Newly revised government figures show that productivity rose at a 2.2% annual rate instead of 1.6% in the third quarter of the year and unit-labor costs were also revised higher to show a 1.8% annual increase. Supporting this, in yesterday’s speech Yellen said she was "looking forward" to a U.S. interest rate hike that will be seen as a testament to the economy's recovery from recession. She added that holding rates at zero for far too long could pose a risk to financial stability.

Last Friday, Non Farm Payroll came out slightly stronger than forecast at 211k against forecast figure of 201k. This positive figure once again adds to the argument for the US rate hike on the 16th of December. The overall unemployment rate remains unchanged at 5% which again is a positive indicator for the rake hike argument. It seems that all eyes will be firmly focused on 15th and 16th of December. That being said, we may see markets be a bit more range bound during the start of the week, with things getting a bit more interesting after Thursday. 

Lastly, oil prices fell to the lowest level in more than six years amid speculation that a record global glut will be prolonged after OPEC effectively abandoned its long-time strategy of limiting output to control prices. Along with WTI and Brent both seeing significant softness yesterday to see Brent futures reach their lowest level of the year after OPEC failed to cut their output. This saw the likes of CAD, NOK and RUB all fall against the USD. In fact, Canadian Dollar fell to an 11-year low, the Russian Ruble to its lowest level in three months, while the South African Rand dropped to another all-time low. 

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