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Have the actions of Draghi and the ECB sentenced the Euro to a fall below the 1.20 level?

Mar.13.2018 17:00 pm Asia/Dubai
By Konstantinos Anthis , Head of Market Research
Euro
Mario Draghi
US Dollar

Have the actions of Draghi and the ECB sentenced the Euro to a fall below the 1.20 level?

The Euro enjoyed a good start to 2018 climbing above 1.22 in response to the weakness the Dollar had shown at the end of 2017. Even when the greenback started picking up momentum the shared currency was able to hold on its own ranging between 1.22 and 1.25. This robust performance was underpinned by the positive growth in the Euro area which shaped expectations that the ECB would begin unwinding their QE program earlier than anticipated, with the summer of 2018 being discussed as an initial target date.

However, even though investors were buying the hype and preparing themselves, and their portfolios, for a more aggressive ECB this year they might have jumped the gun. Mario Draghi was widely expected to announce a tighter monetary policy at his press conference after the March ECB meeting, but this did not happen. Instead, the head of the central bank noted the risks from the lagging inflation which has not yet met his desired levels, the rise in protectionist policies and signaled that policy will remain accommodative for some time. His cautious tone coincided with a downtick in Eurozone’s performance and growth and even though the latest data is only just off multi-month high levels, it still poses a risk for Draghi and the ECB.

Eurozone Manufacturing and Services PMIs recently retreated from their multi-month highs.

Eurozone Retail Sales show weakness over the past 2 months – an effect of an expensive currency?

So what should we expect from the Euro going forward? Was this an attempt by Draghi to manage expectations, which will allow him to introduce a positive tilt in the ECB rhetoric at a gradual pace, or is it a genuine effort to communicate that interest rates will remain low until late in 2018? In my opinion, Draghi has always been a patient policymaker who would rather risk falling behind the curve rather than going in too fast. His approach has helped the Euro area achieve a steady recovery and sustain a positive rate of growth in recent years so it’s unlikely that he will change his tactics now.

Draghi will attempt to ride this wave of slower – but still positive – growth in Europe by reiterating that changes in policy are “data dependent” – his favorite combination of words – and that monetary accommodation will be reduced when needed. This clearly points towards a harder time for the Euro that is now trading around its five-year average, an area that Draghi should be satisfied with. For investors though this suggests that re-positioning is needed and already large institutional players and leveraged accounts are reducing their long exposure to the Euro.

But the most intriguing question is what will happen when this outflow of money drives the shared currency near the 1.22 base – especially at a time when the US economy is enjoying a positive string of data which is pushing the Dollar higher. The February US CPI report might have printed in line with expectations allowing the Euro some room to breathe but it is obvious that traders are not willing to follow the shared currency higher. Should the US domestic performance become even stronger and inflation – both in prices but also earnings – pick up pace, the 1.22 key support will come under threat and most likely give way. In conclusion the next two months will be tough for the single currency and I wouldn’t be surprised if we see prices dropping to 1.20 by mid-Q2 which represents a nice 2.5% profit opportunity for those willing to take a chance on it.

A break below 1.22 will clear the path towards 1.20 if Eurozone continues to under-perform and Dollar gains.

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