Euro Bursts Higher As ECB Talks Recovery

Forex traders drove the euro higher on the back of the European Central Bank's monetary policy decision. While the ECB left interest rates unchanged at 0.50%, slightly more optimism from Mario Draghi was enough to send the currency to a three-week, almost four-week high. Draghi spent a bit more time this month talking about the improvements in economic data and their expectations for stabilization and a gradual recover in 2013. However he did not rule out the possibility of negative rates and instead made it clear that this option was discussed along with ABS, LTROs, collateral and credit claims. Therefore the main takeaway from the ECB today is that all options are still open but their expectations for stabilization reduces the chance for additional stimulus.

Essentially Rules Out Asset-Backed Securities
We have long felt that even though policymakers introduced the idea of negative deposit rates, the bar is high and with ECB officials divided on its efficacy, the euro zone economy needed to deteriorate significantly for the central bank to resort to this option. Draghi basically ruled out buying asset-backed securities by saying that it would take a prolonged time to get a plan function and more importantly, the market has been dead for many years. The central bank also did not address other types of forward guidance and together, these all confirm that there is very little urgency right now to follow up last month's rate cut with additional easing.

Part of the reason is because even though the ECB cut their growth and inflation forecasts this year, they raised their GDP forecast for 2014, reflecting their expectations for stronger growth next year. They now expect the economy to contract by -0.6% in 2013 versus a prior mid range forecast of -0.4%. GDP growth for 2014 is now expected to reach 1.1%, up from a prior forecast of 1.0%. The risks to their outlook remains to the downside because of structural reforms but exports along with accommodative monetary policy are expected to be the driver of recovery. Inflation risks are broadly balanced but CPI is now expected at 1.4% this year versus 1.6% because of the volatility in oil prices.

So while the ECB is keeping monetary policy easy and all of their options open, their brighter outlook means they aren't poised to pull the trigger on additional stimulus anytime soon which was enough for FX traders to buy euros. However the sustainability of its gains now hinge on Friday's U.S. nonfarm payrolls report. If job growth slowed last month, profit taking on long dollar positions could drive EUR/USD above 1.32. Based on yesterday's non-manufacturing ISM and ADP reports, the risk is skewed to the downside for NFPs but jobless claims have been low, providing an ounce of hope for the market. This morning's releases also helped with job cuts dropping 41.2% in the month May according to Challenger Grey & Christmas and jobless claims falling to 346K from 357K.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.