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Post-ECB Rally Looking Toppy as Euro Data Continues to Disappoint

Post-ECB Rally Looking Toppy as Euro Data Continues to Disappoint

James Stanley, Senior Strategist
Post-ECB Rally Looking Toppy as Euro Data Continues to DisappointPost-ECB Rally Looking Toppy as Euro Data Continues to Disappoint

Fundamental Forecast for Euro: Bearish

The first week of the year has brought just the most recent allotment of bad data out of the Euro-zone. This week has seen disappointments in German inflation, German unemployment and Euro zone inflation figures. So, not a great week on the data front for Europe. But this isn’t really a surprise, is it? This is just more of the same that much of the world has become accustomed to. Europe is contracting. The bigger question here revolves around the ECB, and what they might actually do at their next policy meeting. Because after the disappointment that the ECB brought to markets in December, numerous questions have remained as to what they may actually do.

To bring you up to speed Europe is and has been in a really tough spot. Not just economically, but politically as well, as this economic weakness has become so profound that we’ve begun to see political ramifications get impacted. And the primary pressure point of the situation still exists: There is no banking Union. We have 18 individual fiscal policies from 18 separate and individual nation-states, all being governed and managed by one, single monetary policy.

In good times, when markets are growing, this isn’t necessarily a ‘bad’ thing. But when pressure is being felt – it becomes a really threatening component because, as you might imagine, each of these 18 member states have different drives and motives with different ideas as to how to correct the problem. This is likely why we didn’t see an increase in the QE package in December: Gaining adequate political support for such a move was likely impossible. And Europe, right now, is very much centered on politics.

But where is the trade?

Well, it looks like the predominant trend in the Euro is coming back, and that is the course of weakness. Because the dichotomy in rate expectations between Europe and the rest of the world is still continuing to grow; and that’s likely not going to change until something very different happens in the global economy. Even with all of the massive risk aversion that’s taken place this week, EUR/USD has been unable to punch through to a ‘higher-high.’

The driver of this is, likely, the expectation that the ECB will eventually step up to the plate and increase the QE-package in an effort to offset this dizzying array of negative data points. The ECB is in somewhat of a similar position as the Bank of Japan in October of 2014. They’ve already triggered QE and made a huge wave in markets, so they’re fairly committed to this route. But they also haven’t seen any signs of progress, so it can be difficult to gain support for an increase to QE when it hasn’t really shown any signs of improvement in the ‘real’ economy.

And because of that, we will likely see continued focus on European data points as traders juggle probabilities of QE-increases at future ECB meetings. The big data point for Europe next week is on Thursday as Germany reports GDP, and the expectation is for a 1.6% one-year clip.

We also get Euro-zone Industial production figures on Wednesday, and this could be market moving; although the issues in Europe go far beyond a slowdown in manufacturing, so this may be taken as nothing more than a wayward data point should it beat expectations. Keep January 21st marked on your calendars – because that is the next ECB meeting and we may get more information on the potential for an increase in QE there, but more likely, we’re looking towards March for any ‘big announcements’ so that the bank could get some additional data in response to the deposit rate cut that took place in December (this was the one thing that actually was changed).

If Europe hasn’t seen any additional optimistic signs of recovery by this March meeting, and if we do not get an increase in the European QE package, this situation could get significantly worse as political pressures have begun to rage across the continent, even in stalwart of the continent in Germany. Combine this with a burgeoning refugee crisis and the rest of the world may have some very large issues to contend with around this theme.

For now – we take forward a bearish forecast on the Euro under the presumption that investors will continue to increase anticipation of an increase to the European easing package.

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