EUR rallies despite contractionary PMIs - how the ECB will see it

On Thursday we outlined three main factors that could affect how currencies trade – the election, stimulus talk and economic data. As it turns out, data was the leading driver of currency flows on Friday.  The dollar traded lower against most of the major currencies with the exception of sterling. PMIs were the main focus and to everyone’s surprise economic activity did not slow as much as expected in most countries during the month of October.

Improvements were seen in Germany’s manufacturing PMI index which helped to mitigate the decline in services.  Services and manufacturing activity expanded at a faster pace in the US and for Australia, faster growth in services offset the decline in manufacturing, allowing the composite index to rise. Not all news was good news - in Japan, the manufacturing PMI index increased while the service sector PMI index declined. In the UK, service and manufacturing activity slowed. These reports are important because they tell us just how much damage the second wave is having if at all on regional economies.

With central bank monetary policy meetings kicking off next week, these reports could effect on immediate policy guidance. More specifically, all eyes will be on the European Central Bank as they are widely expected to ease monetary policy before the end of the year. Although the Eurozone’s composite PMI index showed a return to contraction, the upside surprise in the flash composite and manufacturing numbers were good enough for euro traders to erase Thursday’s losses. Not only is EUR/USD closing in on a 1 month high but it was the best performer on Friday. While the deterioration in PMIs is bad news investors continued to shrug off a pandemic that is quickly getting out of control in Europe. Part of that has to do with money flowing out of US dollars but most governments stopped short of a full nationwide lockdown, preferring to impose regional restrictions and curfews. Nonetheless the prospect of unambiguously dovish comments from ECB President Lagarde next week should cap gains in the euro.  

Meanwhile no changes in monetary policy are expected from the Bank of Japan and Bank of Canada but the BoJ could lower its economic assessment.  Despite stronger retail sales, weaker than expected UK PMIs kept sterling under pressure. Investors are also growing weary of Brexit negotiations and starting to drive the currency lower.

In the US, House Speaker Pelosi kept the hope alive when she said a package can be passed before the election IF President Trump backs it. However stocks sold off after Treasury Secretary Mnuchin said there are still “significant differences.” In reality, the clock is ticking and with Trump trailing in the polls, Pelosi won’t be too eager to reach an agreement before the election. Equity traders are still very sensitive to stimulus headlines but FX traders have grown numb to the back and forth. Like Europe, virus cases are rising rapidly in the US but states have not imposed many new restrictions which is the key to confidence, spending and growth.  Still with less than 2 weeks until the election, volatility could be bigger than usual as investors adjust their exposure ahead of this high risk event.