It’s Not A Good Idea To Buy The Euro

Why Buying EUR Now is Not a Good Idea

The euro ended the day slightly lower against the U.S. dollar, but its nasty intra-day reversal tells a story of a clear change in sentiment. At the beginning of Mario Draghi's post ECB press conference, investors drove EUR/USD to a fresh 2.5-year high 7 pips shy of 1.40 when it seemed like the central bank had nothing new to offer. However as the press conference progressed, Draghi revealed more and then during the Q&A session he dropped a bomb on the euro when he said the central bank is comfortable with easing after the staff forecasts are released in June. Some investors may be tempted to buy euros on the back of this decline but it's a bad idea. The ECB made it known that they are preparing to increase stimulus and no other major central bank is in the same position. In fact, the RBNZ is tightening, the Fed is reducing stimulus and the market thinks the BoE will be the next to raise rates. From a monetary policy perspective, this makes the euro extremely unattractive in the near term. Also considering that the next ECB meeting is on June 5th, approximately 2 weeks before the next Fed meeting the risk is to the downside for EUR/USD. At bare minimum, we are looking for a minimum move down to 1.3700. If the central bank eases next month, their most likely course of action will be a cut to the refi rate and/or move to a mildly negative deposit rate.

Given the trend of inflows into Europe and the low level of interest rates, a further cut by the central bank should only drive the euro down to 1.37-1.3650. Going into Thursday's press conference investors were looking for 2 things - an intensification of criticism of the euro or a clear sign that the ECB is ready to increase stimulus over the next few months and Draghi delivered on both. He called the strengthening of the exchange rate a "serious concern," which alone would not have been extremely negative for the euro but the currency crashed when Draghi also indicated that the central bank was ready to ease next month. Despite an increase in economic activity and uptick in inflation in April, the ECB feels that an extended period of low inflation, the risks to the economic outlook and a strong euro puts enough pressure on the region to warrant additional accommodation. As one of the few central banks planning to increase stimulus, the ECB's stance alters the near term outlook for euro.

My Top Takeaways ECB Press Conference

Here's everything you need to know about the key points made in the press conference

1. ECB Comfortable with Acting in June after Staff Forecasts are Released
2. Strengthening of Exchange rate in Context of Low inflation is "Serious Concern"
3. Concern over FX rate will have to addressed
4. Strong EUR caused by inflows
5. The era where the ECB never pre-commits ended "a long time ago"
6. Sees Downside Risks to Economic Outlook, cites Financial, Emerging Market and Geopolitical risks
7. Ready to act swiftly if needed. May consider unconventional measures. Sees rates at present or lower level if needed
8. Firmly reiterates Forward Guidance
9. The longer the period of low inflation, the longer the risk of de-anchoring expectations
10. Inflation risks broadly balanced, to rise gradually in 2015
11. Survey data consistent with continued moderate recovery. EZ unemployment stabilizing
12. Moderate recovery proceeding as expected. Prolonged period of low inflation, then prices to rise gradually after

Dollar Sinks as Yields Extend Lower

While the U.S. dollar traded higher versus the euro and Swiss Franc Thursday, it held steady or weakened against other major currencies. The rally in EUR/USD and sell-off in USD/CHF had nothing to do with the market's appetite for dollars. Instead, dovish comments from the ECB drove investors out of European currencies. Meanwhile the continued slide in Treasury yields kept the pressure on the greenback. In contrast to Mario Draghi, Janet Yellen provided very little clarity on monetary policy this week, keeping the downtrend in yields intact. A larger-than-expected decline in jobless claims from 345k to 319k provided very little support to the dollar. Continuing claims also edged lower to 2.685 million from 2.761 million. Janet Yellen testified before the Senate Budget Committee this morning and the only interesting thing she said was that she is not in favor of raising the inflation goal and interest rates are not likely to rise unless the recovery strengthens. Neither of these comments is earth shattering but they do confirm that while the central bank is tapering, they don't want to pre-commit to tightening. FOMC voters Plosser and Tarullo also spoke this morning. Tarullo didn't touch on monetary policy but Plosser is optimistic about the economic outlook, warned against unintended consequences of ultra-easy monetary policy and urged the central bank to clarify its interest rate path. As one of the most hawkish members of the central bank, his positive comments are not out of character and therefore had very little impact on the dollar. No major U.S. economic reports were scheduled for release Friday but FOMC voter Fisher -- who is also a hawk -- will be speaking on monetary policy.

CAD Hits 3.5-Month Highs Ahead of Employment

The Canadian dollar soared to a 3-month high against the U.S. dollar (CAD/USD) Thursday ahead of Friday's employment report. While manufacturing activity deteriorated in the month of April, the sharp increase in the employment component of the report signals the possibility of an upside surprise. The strong job growth in March will be difficult to beat but the forecasts for this month's report is low. The Canadian dollar also received a boost Thursday from better than expected housing market numbers. Housing starts jumped 38k to 194.8k in the month of April. House prices also rose 0.2%, driving the annualized pace of growth up to 1.6% from 1.5%. The housing market is one of the BoC's biggest areas of concern this year but the latest economic reports suggests that a soft landing is underway. The best performing currency Thursday was the Australian dollar, which soared on the back of a stronger employment report and Chinese trade numbers. More than 14k jobs were created in the month of April, keeping the unemployment rate steady at 5.8%. Not only was last month's report better than expected but job growth in March was also revised higher. All of the gains came from full time employment, which is an extremely positive development for Australia's economy. Earlier this week, the RBA left monetary policy unchanged and the improvement in the labor market justifies their steady bias. The minutes from the meeting were scheduled for release Thursday evening and an optimistic tone could drive AUD/USD toward its 5-month high of 0.9461. As our colleague Boris Schlossberg indicated Thursday morning, "Chinese Trade balance came in better than expected rising to 18.6B versus 16.7B projected. Exports rose by 0.9% and imports increased as well to 0.8% indicating that growth in China remains robust and the PBOC is unlikely to engage in any additional stimulus for now."

GBP: BoE Leaves Monetary Policy Unchanged

The Bank of England left monetary policy unchanged this morning and as usual when that happens, no details were given. Nonetheless the British pound ended the day slightly lower against the U.S. dollar (GBP/USD) because a small subset of investors was hoping for hawkish comments from BoE Governor Carney. While the head of the U.K. central bank chose to release a more detailed statement at the start of his term at the BoE, since then he stuck with tradition and relegated additional insight to the release of the minutes 2 weeks later. Also, if the central bank were to express a more hawkish bias, they would most likely prefer to wait until the Quarterly Inflation Report is released next week. The BoE statement noted that the latest economic projections would be provided in the Quarterly report and Sterling could hold onto its gains ahead of this key event.

Base Currency Movements Drive the Yen

The Japanese Yen traded higher against all of the major currencies Thursday with the exception of the Australian and Canadian dollars. The lack of Japanese economic data overnight meant that the move in the yen pairs was driven entirely by the market's appetite for the base currency. Unsurprisingly, the weakness of the euro made EUR/JPY the day's worst-performing currency while the strength of CAD and AUD helped CAD/JPY and AUD/JPY outperform all of its peers. As this is an extremely quiet week for Japanese data, there will be very little focus on Japan. Stocks also provided little guidance because after Wednesday's steep slide, the Nikkei recovered overnight.

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