All About ECB And US Jobs

There are two main forces at work as the week winds down. The first is the ECB’s confirmation of its asset purchases. This has renewed the rally in European peripheral bond markets and re-accelerated the euro’s slide. The second is the US monthly employment report, which follows a string of relatively soft economic data. 

The euro bounced initially on ECB President Draghi’s remarks, reaching almost $1.1115 before being sold off briefly through $1.10. Follow through selling today has seen it fall toward $1.0960.  The sell-off is dragging down other European currencies, including sterling, where the May election polls highlight the likelihood of a coalition government.   It is difficult to find any meaningful chart support, but there is some talk of the $1.0750 area as the next target.  

In January, the euro slid 6.6% against the dollar. In February, it fell less than 1%. Some participants are seeing the loss of downside momentum as a sign that a significant bottom was at hand. Given the underlying divergence of monetary policy, which strikes us as unprecedented, we suspect the dollar bull market/euro bear market is a little more than half way to where it is ultimately going in this cycle. The euro peaked last May near $1.40.  It has fallen 30 cents. We anticipate it falling toward euro’s record lows set in 2000 near $0.8200 and have suggested an $0.8500 target by the end of next year. This is not simply about fair value. It is understanding that such powerful moves in the foreign exchange market most often do not end before any reasonable model of fair value is overshot.  

The ECB’s new forecasts seem optimistic.  Growth this year is now expected to be 1.5%, up from 1.0% it estimated four months ago and next year’s GDP is seen at 1.9%. Even its inflation forecast seems optimistic and largely hinges on its oil assumption, which is simply taken from the futures curve. Zero on average this year means a sharp increase at the end of the year. Next year’s forecast is for harmonized CPI to reach 1.5% and then 1.8% in 2017. This implies the ECB anticipates reaching its target then which is close to but less than 2%.