Daily Forex Signals 07.09.2017

EUR/USD: Will cautious ECB stop EUR appreciation?

Macroeconomic overview: European Central Bank policymakers hold a widely anticipated meeting later on Thursday, amid speculation the central bank wants to wind down its extraordinary bond-buying monetary stimulus soon.

However, this year's surge in the euro exchange rate complicates the ECB's exit strategy. It curtails already sub-target inflation by making dollar-priced imports cheaper, dragging down the booming export sector and cutting into corporate earnings from outside the bloc.

Any mention of the euro and its relative impact on financial and economic conditions, as a result, may be the biggest market mover today.

The euro's more than 13% rise against the dollar so far this year, its biggest in 14 years, puts the currency at the top of investor watch lists. On a trade-weighted basis, the euro has gained nearly 6% in less than five months. That strength creates obstacles for both economic growth and inflation in the euro zone. The euro strength could delay ECB plans to roll back stimulus, and Draghi is sure to be asked about the currency in the post-meeting news conference.

We estimate that the euro strength could subtract a cumulative 0.4 pp from eurozone GDP growth in 2018-2019, and we suspect that ECB models may point to an even larger drag. However, we do not think that the ECB will reduce its growth forecasts by a similar amount, because there are offsetting factors coming to the rescue, primarily the current stronger-than-expected growth momentum in the wake of solid domestic demand. This means that the short-term GDP outlook is likely to be slightly firmer than the ECB had assumed in June, while the drag of FX appreciation will progressively prevail further out in the forecast horizon. Overall, the GDP forecast for 2017 might be raised by 0.2pp to 2.1%, while that for 2018 and 2019 could be reduced by a cumulative 0.2-0.3pp from the current 1.8% and 1.7%, leaving the output gap broadly in line with the June estimate. On the inflation front, however, the bias is for lower projections. The 1.5% forecast for 2017 is on track, but a stronger currency and lower assumptions for euro-denominated oil prices suggest downward pressure on the numbers for 2018 and 2019, currently at 1.3% and 1.6%. We expect both projections to be lowered by 0.1pp even though, mechanically, the elasticities generally used by the ECB in its simulations would suggest a larger drag. It is likely that these revisions – starting from already weak inflation levels – will make the ECB nervous.

Markets have pushed back expectations for when the ECB will signal a scaling back of its stimulus, to October from September. We do not think that the change in projected inflation path is large enough to derail the tapering, because with technical constraints set to become increasingly binding, the risk-reward balance of further asset purchases will progressively deteriorate. Therefore, weaker inflation forecasts can probably be overlooked as long as the output gap remains on the right (narrowing) path. In this respect, the picture remains constructive and broadly unchanged from June, especially after the first tentative signs of reacceleration in core inflation. Vanished risk of deflation and stock-vs.-flow considerations (with M. Draghi stressing the key role played by the reinvestment policy) will also help keep the ECB on track for a tapering announcement relatively soon. However, it has become increasingly likely that the ECB will have to exit slowly, otherwise markets may drive the euro even higher.

The ECB seems to have two main options today: 1. Announce a slow and open-ended tapering, broadly along the lines of our baseline trajectory envisaging monthly asset purchases of EUR 40 bn until June 2018 (or beyond if needed), while retaining the commitment to step up asset purchases if the outlook deteriorates or financial conditions tighten excessively; or 2. Postpone the tapering announcement until the October meeting and start verbal intervention focusing on financial conditions, the ECB reaction function and resolution to counter any unwarranted tightening. The Governing Council might also decide to include currency appreciation in the list of downside risks.

We think the ECB will go for the second option. In July, M. Draghi stated the ECB wants to have all the available information before making a decision, adding that this information will “certainly” be available by autumn. By definition, the 26 October meeting will allow the ECB to gather more data, with the most sensitive additional releases being the September and October rounds of business surveys (where the initial impact of euro appreciation should be felt), and the September core CPI reading (here any noise related to the price of holiday-sensitive services should dissipate).

Technical analysis: The rising 14-day exponential moving average is a hope for the EUR/USD bulls. Slow stochs are upticking from OS levels and favor further upside action. A break of last Friday’s 1.1980 peak would open way to above 1.2000. However, today’s ECB statement may change the market picture.

EURUSD Daily Forex Signals Chart

Short-term signal: We will be looking for corrective moves to open a long position. Today’s ECB statement may trigger some profit taking on EUR/USD long positions.

Long-term outlook: Bullish


USD/CAD: Profit taken on short position after BoC surprised with second rate hike

Macroeconomic overview: The Bank of Canada raised interest rates yesterday and left the door open to more rate hikes in 2017 even as it pledged to pay attention to how higher borrowing costs would hit Canada's indebted households.

The 25-basis-point increase to 1% followed a hike in July and puts Canada ahead of the curve in returning borrowing costs to more normal levels after they were slashed due to the 2007-2009 financial crisis. While the U.S. Federal Reserve has begun tightening, its pace has been slower.

The Bank of Canada said the hike was warranted given unexpectedly strong economic growth in the second quarter, but said future moves are not predetermined and would be guided by data and market developments.

The Canadian dollar surged more than 2% after the announcement to its strongest since June 2015 at CAD 1.2138, while the 2-year yield jumped as much as 10 basis points to its highest since April 2012 at 1.450%.

The tone of the statement that accompanied the rate decision had not moderated at all since July, when the bank raised rates for the first time in nearly seven years.

The market had widely expected the Bank to reverse the two rate cuts it made in 2015 amid a decline in oil prices that sideswiped Canada's energy-dependent economy. Now that the so-called insurance has been removed, the next step is less certain, particularly given the vulnerability of Canada's indebted consumers and housing market to higher interest rates.

Markets will now be watching both economic data and a speech by Bank of Canada Governor Stephen Poloz scheduled for September 27 in which he is expected to provide an economic update. We think that further interest rate hikes are likely with one more hike already this year.

Canada's trade deficit in July shrank to CAD 3.04 billion, thanks largely to a strong Canadian dollar that cut the value of imports. The value of imports fell by 6.0% from June, with lower prices accounting for most of the decline. The robust domestic currency also depressed the value of exports, which dropped by 4.9% after falling by 5.0% in June. Many major exporters price their goods in USD, which means they receive fewer Canadian dollars as the currency strengthens.

Technical analysis: The USD/CAD drop was stopped slightly above support level of 1.2128 (low on June 18, 2015). A break below this level would open the way to 1.1920 low on May 14, 2015.

USDCAD Daily Forex Signals Chart

Short-term signal: Profit taken on USD/CAD short yesterday. In our opinion long-term outlook remains bearish and we are looking to sell again at 1.2395.

Long-term outlook: Bearish




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