The Euro extended its slide yesterday just a couple of days ahead of the ECB monetary policy decision due tomorrow. The shared currency has seen quite a retreat over the past few days, trading lower ever since it had reached the 1.1280 area on the back of elevated expectations - at that time - for a more aggressive easing initiative from the Fed. When the Euro drove higher last week we expressed our doubts on whether the gains could last and it seems that market participants agreed with us, taking advantage of the opportunity to short the currency at a higher price.
Looking ahead, the broader bias for the Euro looks rather weak but its short-term action depends on what the ECB will deliver tomorrow. The odds for an immediate rate reduction remain low at this time and this seems reasonable given that the European Central Bank usually prepares the markets for its next action before eventually pulling the trigger. As such, we believe that Draghi will not ease policy tomorrow but instead look to hint on doing so in September. Having said that, the tone of his remarks and whether he appears committed in moving forward will dictate the way the Euro will react: a dovish Draghi making references to the low inflationary environment, sluggish domestic growth and persisting geopolitical risks will keep the currency under pressure and could send prices further to the downside towards the 1.1120 support.
However, if he sounds hesitant and instead prefers not to commit to acting very soon, the Euro will likely look to recover higher in a hurry. Investors are heavily short on the currency and given that the Fed is widely expected to ease policy at the end of the month, any sign of hesitation from the ECB to follow suit could trigger a short-covering rally in the Single currency. In our opinion, the odds for the latter scenario - Draghi not hinting on the ECB easing very soon - are very low and we favor a bearish bias on the Euro. The German and Eurozone manufacturing and services PMIs are due to be released today and barring an extraordinarily positive surprise in the figures, the case for the ECB remaining on a dovish stance appears solid.
Elsewhere, the US manufacturing and services data is also pending for release later today amid a rather robust performance from the Dollar over the past few days. With the Fed almost certain to cut rates by 0.25% next week, these fresh figures should help shape expectations for what’s next. Economists expect the reports to print in a positive manner which should help keep the Dollar supported. In the UK, Boris Johnson is the new Prime Minister and the way he handles the Brexit process will drive Sterling. Yesterday, he again committed to taking the UK out of the EU by October 31st but with little progress on that front, it seems quite a challenge. We should wait to see his first actions on that front before deciding on how the Pound will trade going forward.
Equities were positive across the board yesterday with the European markets advancing by 1.2% on average and their US counterparties closing around 0.5% in the green. There are two conflicting catalysts for stock traders right now: on one hand, central banks around the world are about to embark on an easing initiative, which is always helpful for the stock markets. On the other though, the slowdown in growth on a global scale and various geopolitical factors keep weighing down on corporate profitability, asking questions on whether equities have peaked. As such, futures this morning are trading flat and it will be interesting to see which side - the bulls or the bears - will win the fight of the day.
MARKET EVENTS TO WATCH
- Eurozone Manufacturing/Services PMI - 12pm
- US Manufacturing/Services PMI - 17.45pm
All times are GMT +4.
Written by Konstantinos Anthis, Head of Research