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by Charalambos Pissouros

EUR Slides on Draghi’s Comments Over Rates; Pound Tumbles as Barnier Rejects UK Trade Plan

Yesterday, the euro traded lower against most of the other G10 currencies following Draghi’s remarks at the press conference following the ECB policy decision. The President said that market expectations on interest rates are aligned with the anticipation of the Governing Council. The pound slid as well after EU Brexit Negotiator Barnier rejected key parts of the UK’s customs plan.

Draghi Says Market Expectations are Aligned with the ECB’s Anticipation

The euro traded lower against the majority of its G10 counterparts yesterday. It gained slightly only against NZD, while it traded virtually unchanged against GBP and AUD. The common currency underperformed the most against USD, JPY and CAD in that order.

Yesterday, the main event for euro traders was the ECB policy decision. The Bank decided to keep monetary policy unchanged and proceeded with little changes in the accompanying statement. Thus, the euro remain unfazed at the time of the release, with investors waiting for President Draghi’s press conference.

In his introductory statement, Draghi noted that the latest economic indicators have stabilized and continue to point to ongoing broad-based economic growth. He also repeated that underlying inflation remains generally muted but is expected to increase gradually over the medium-term. Following the increased tensions on the global trade arena, and perhaps the latest slide in the composite PMI for June, investors may have been worried that the Bank could change its language around the economic outlook. Although Draghi reiterated that the threat of protectionism remains prominent, he also repeated that the risks surrounding Eurozone’s economic outlook remain broadly balanced, which may have been the catalyst behind euro’s initial appreciation.

However, those gains did not last for long. The common currency came under selling interest  as soon as the "through the summer of 2019" interest rates guidance took center stage. According to market chatter, many participants were trying to get a clearer message using various translations, but when the President was asked about the ambiguity of the phrase, he said “the only version that conveys the policy message is the English version. We conduct our Governing Council in English and agree on an English text, so that's what we have to look at”. He also added that according to money markets, expectations of the future rate path are very well aligned with the anticipation of the Governing Council, backing the market consensus for a hike in late 2019. This may have come as a disappointment to those expecting to get clues that summer months are also candidates for such a move.

All these are more or less in line with what we have anticipated in our report yesterday and thus, we maintain the view that the euro could stay under selling interest in the near term, at least against its US and Canadian counterparts. Yesterday’s meeting confirmed that market participants may have very little room for bringing forth their ECB hike expectations, at a time when they see a near 63% chance for the FOMC to increase rates two more times by year end,  and expect the Bank of Canada to continue with its gradual approach on interest rates, perhaps hiking once more this year. This divergence in monetary policy expectations could work against EUR/USD and EUR/CAD we believe.

On top of that, the latest upbeat news around NAFTA could continue to be a positive driver for the Loonie. On Wednesday, Mexican and Canadian officials appeared optimistic that they can reach a deal with the US in the next several months, while yesterday, US Trade Representative Lighthizer said that it’s possible for NAFTA partners to reach a tentative agreement next month. US Treasury Secretary Steven Mnuchin added more to the optimism by saying that he is hopeful they will have an agreement in principal in the near future.

EUR/CAD – Technical Outlook

EUR/CAD is feeling the heat this week and keeps moving south. The pair has fallen sharply in the past 3 days and it seems that it could continue its route in the same direction today. EUR/CAD found its support yesterday at around the 1.5210 level, which could just be a short-term pitstop before the pair decides to continue dropping.

For now, we will keep a close eye on the 1.5210 zone, a break of which could open the path towards the next potential area of support, at around the 1.5175 hurdle. On the 15th of June, after a strong sell-off, we saw the pair reversing back up from that level and making its way higher. Another drop below that hurdle could set the stage for the 1.5115 level, marked by the low of the 14th of June. Slightly below we have the 1.5080 barrier, which held the rate from dropping further on the 1st of June.

On the upside, a strong reversal back up and a move above the 1.5255 line, which acted as a good area of support on Wednesday but then became resistance, could open the door to the 1.5305 obstacle, marked by yesterday’s high. If the 1.5305 level is not able to withhold the rate from accelerating further, then EUR/CAD could move towards the 1.5355 mark, or even higher to the 1.5430 line, which acted as good resistance between the 10th and the 12th of July, and then again on the 23rd

Barnier Rejects Key Points of the UK’s Customs Proposal

Given that it was virtually unchanged against the euro, the pound traded in a similar fashion against the other G10 currencies. It gained only against NZD, while it lost the most ground versus USD, JPY and CAD.

Brexit developments came back in the limelight yesterday, with the EU Brexit negotiator Michel Barnier rejecting main points of the UK’s new proposal on the EU-UK trade relationship after Brexit. At a joint conference, both the EU Brexit negotiator and the new UK Brexit Secretary Dominic Raab said that there was progress in their talks, but “obstacles” remained before reaching a deal in October. Barnier dismissed the UK offers saying, “The EU cannot and the EU will not delegate the application of its customs policy and rules and VAT and excises duty collection to a non-member who would not be subject to the EU’s governance structures.”

We’ve been highlighting the risk for the plan to get rejected by the EU for some time now. We said that EU officials may see the plan as “cherry picking” and thus, we viewed its approval as unlikely. We believe that the pound could have tumbled further if the market was not so overwhelmed over a BoE rate hike next week. With the currency being trapped between a rock and a hard place, GBP-bulls are unable to enjoy lasting gains. On the one hand, there are high expectations for a BoE rate hike on Thursday, but on the other one, as we get closer to the EU-UK divorce date, uncertainties around Brexit increase.

GBP/NZD – Technical Outlook

Since around the 18th of July, GBP/NZD has been gradually moving higher. Looking at the 4-hour chart of GBP/NZD, we can see that the pair started forming a rising wedge, which theoretically could be a bearish sign for the pair. Certainly, until we get a break through the lower side of the wedge, we cannot confirm the downside yet. That’s why for now, we will remain neutral and observe the price action within that formation.

If eventually a break of the lower side of the wedge happens, this could open the path towards some key support areas. The first one to watch could be the 1.9270, marked by yesterday’s low. A further drop below could interest more bears, who in their case, could pull GBP/NZD down to the 1.9230 level, or even the 1.9195 area, which was near the lowest point of July.

Alternatively, if GBP/NZD makes a move higher towards the 1.9360 line, breaks it, and then tests the upper side of the wedge, we should remain cautious, as the bulls might decide to take the pair out of that formation. If the move higher continues, then GBP/NZD could reach the 1.9400 resistance level, a break of which could trigger further buying and the pair could make a move towards the 1.9430 hurdle, marked by low of the inside swing low of the 13th of July. 

As for Today’s Events

The most important release of the day is likely to be the first estimate of the US GDP for Q2. The forecast suggests that growth accelerated to +4.1% qoq from +2.0% in the first three months of the year. The case for accelerating growth supported by the Atlanta Fed GDPNow model which estimates Q2 growth at 3.8%. That said, according to market chatter, US President Trump said he expects Q2 GDP to rise to as much as 4.8%.

So, having that in mind, we believe that the dollar may not gain much if the forecast is met, even if this will strengthen the case for the Fed to proceed with two more rate increases this year. The greenback has strengthened across the board yesterday, perhaps in anticipation of a stellar print. Thus, we believe that the actual number may need to exceed the forecast by a decent margin, perhaps to come in near Trump’s expectation, in order for the dollar to extend notably the gains it posted yesterday.

As for the speakers, we have only one on today’s agenda: St. Louis Fed President James Bullard.


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