EURUSD: Time for a dovish Draghi to reappear

In anticipation of the ECB interest rate decision this afternoon, there has been some signs of Eurodollar purchasing in the early morning hours with the pair trading as high as 1.2673. Although I am not expecting any ECB action this afternoon and it wouldn’t surprise me if this encouraged Eurodollar appreciation, the EU’s consistently weak economic performances will make any runs towards 1.27 limited.

Back in August, two distinctive comments from ECB President Mario Draghi stayed with me - “The fundamentals for a weaker exchange rate are today much better than they were” and “the EU economic recovery remains weak, fragile and uneven”. Since then, the EU economic sentiment has worsened significantly. Optimism surrounding the likelihood of German economic data returning to consistency in September wassquashed by fallingIFO expectations, the German ZEW survey deteriorating and, on Wednesday, an unexpected German manufacturing contraction. Additionally, fears over stagnant economic growth alongside deflation have resurfaced - all of this has occurred within the past fortnight.

Draghi’s comments in August have proven to be more than accurate, with the Eurodollar since dropping from the high 1.33’s to 1.2570. Further weakness throughout October is highly likely, and I am expecting Draghi to reiterate how fragile the EU recovery has become on Thursday afternoon. When the Eurodollar declined from approaching 1.40 in May, there was some optimism that this would lead to improved economic performances. So far, we are yet to see this correlation and if we are going to notice the weaker Eurodollar benefit the economic data it might take some more months. Until then, soft PMIs and poor CPI data will continue to encourage investors to price in future stimulus from the ECB.

I remain unconvinced introducing QE is the answer to the ECB’s prayers and it must be remembered the Federal Reserve required three different rounds of QE before US economic data noticeably improvedduring the summer. Additionally, the Bank of Japan (BoJ) remains under continuous pressure to increase QE and although Japanese inflation has risen in recent months, the improved CPI levels were led by the April sales tax which encouraged consumer expenditure. At present, it appears that the ECB’s approach to reinvigorating the economy is to encourage banks to lend and raise consumer borrowing. As such, if the ECB unexpectedly acts again on Thursday we should look forinterest rates to be cut to a flat zero, or negative deposit rates to be increased further.

Although QE will not be introduced from the ECB anytime soon, I agree that the Eurodollar bear run has further room to move to the downside. The majority of US economic releases are outperforming expectations and the Federal Reserve concluding QE in just a few weeks signals the Fed are stepping towards normalizing monetary policy. As long as improved US economic data continues, anticipation will heighten that the Fed will shift to a hawkish bias sooner rather than later. At the same time, the EU economic sentiment is unlikely to improve andI am forecasting the EURUSD to trade at 1.23 around the time the Fed concludes QE.