Why Euro Broke Support Despite ECB Optimism

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

The went on a wild ride Thursday after the European Central Bank’s . The single currency shot up to a high of 1.2210 as Mario Draghi expressed his confidence in the economy but when the ended, it began a deep slide that erased all of its post-ECB gains, taking EUR/USD below 1.2100 to its the weakest level in 3 months.

simply couldn’t overcome the ’s strength as the move coincided with a broad-based rally in the greenback. Nonetheless, after leaving unchanged, ECB President Draghi was surprisingly upbeat during his . He downplayed the recent deterioration in data and talked primarily about their confidence in their outlook for solid, broad-based growth and their view that inflation will converge toward their goal. He saw the downside risks as mostly global and the unexpected declines in data to be temporary because they are “still above historical averages” and Draghi also felt that there is less exchange-rate volatility. While he refrained from discussing their monetary-policy plans including the end of asset purchases, it is clear that the ECB’s goal on Thursday was to reaffirm their confidence in the economy, which should have driven EUR/USD higher and not lower.

The decline in Treasury yields should have also lifted the pair but German rates fell more than U.S. rates, so the yield spread favored weakness. At the end of the day the ECB will not be raising interest rates until 2019 whereas the Fed could lay the groundwork for a June when they meet next week. So in a nutshell, EUR/USD broke below 1.2150 support despite the ECB’s optimism because it failed to overcome the ’s strength, because the yield spread still favors EUR/USD weakness and because in many ways, ECB policy will trail well behind the Fed this year.

The held onto its gains, shrugging off the decline in Treasury yields. U.S. data was better than expected with falling to its lowest level in 49 years. A large part of the decline was due to spring-break seasonality but the less volatile also fell to 229K from 231K. rose 2.6%, against expectations for 1.6% increase while the shrank to -$68B from -$75.9B. are scheduled for release Friday and while investors are positioning for a strong report, the drop in non-defense capital goods orders, the stagnation in , weakness in at the start of the year point to a softer release. Therefore, if GDP falls short of expectations, we could see end-of-week profit taking in the greenback.

The Bank of Japan has a this evening and will be releasing a barrage of economic reports including , , and . The BoJ firmly believes in the need for easy monetary policy so no changes are expected but they will be releasing their latest including their first forecasts for 2020.

Like the , gave up its earlier gains to end the day unchanged versus the greenback. are scheduled for release on Friday. This is the most important piece of U.K. data on the calendar this week and it is expected to show growth slowing in the first 3 months of the year. However with and activity improving, we believe that the risk is to the upside for this report. The U.K. government also held a debate Thursday on whether Britain should remain in a customs union. Interior Minister Amber Rudd cast doubt on May’s plan to leave the union as he’s worried that it would hurt Britain’s ability to sign its own trade agreements. No vote was held but this is a lead-up to a binding vote in May or June.

The and dollars ended the day lower against the greenback while the New Zealand dollar finally stopped falling after 7 days of extensive weakness. New Zealand’s and Australia’s reports were on the calendar Thursday evening. The downtrend for all 3 commodity currencies remain intact, so Thursday’s recovery is still nothing more than relief rally for the time being.