The dollar story ahead of ECB

The US and Canadian markets are closed today for Labor Day hence ıt will be a quiet start to a week that is busy with central bank decisions and a lot of Fed speakers. It will give one more day to ruminate over the August jobs report and whether the very disappointing 235k increase in August or the strength in June and July with respective gains of 962k and 1,053k was the aberration.

That fact alone should keep the Fed on hold for now, especially with the downside risks from the impacts of the spike in Covid/Delta infections and supply chain disruptions.  

The reactions in the markets to the much weaker than expected August headline job miss were unusual and atypical and added to the growing concerns over a measurable slowing in US and global growth. However, there were some offsetting factors to take some of the sting out of the report, including big upward revisions to June and July employment, a drop in the unemployment rate to 5.2% which is a post-pandemic low, and a 0.6% jump in wages.

The numbers were seen as delaying a QE taper announcement, not taking it off the table entirely. Wall Street so far today has posted broad gains, while in Europe if futures are anything to go by bonds won’t manage to recoup much of Friday’s losses, as markets still seem to waiting for the ECB to announce a slight tapering in monthly asset purchase levels this week. Lagarde will play down the importance though and is likely to once again stress the forcefully dovish guidance on the rate outlook and highlight the fact that asset purchases at levels seen in the first quarter would still mean sizeable support.

The key question however remains on whether Friday’s data will prevail and strengthen the US Dollar’s 12-day decline or whether the Greenback could find some footing as markets might wait for further clues on whether the US economy is indeed under threat.

So far in the longterm the value of speculators’ net long US Dollar positions has grown to its largest since March 2020, reaching nearly $11 billion in the week ended Aug. 31, according to calculations by Reuters and US Commodity Futures Trading Commission data released on Friday. This implies there is a wide expectation in the markets for a tapering by the end of the year.

In the near term meanwhile, even though the Fed has not provided a timeline, and given its Chairman’s remarks, a tapering in September is way too soon. After all, it was Chair Powell who recently stated there is still “significant slack” in the labor market, and Friday’s report will only support those concerns. A more hawkish stance has taken hold recently, but the weakness in the US jobs report and the deceleration in global growth is likely to restrain action in the near term. Hence as tapering remains the focal point in the near term (but not for September) and the key driver for the US Dollar, the upcoming Fed speeches and central bank’s decisions will be paramount this week.

Attention now turns to the ECB, RBA, and BoC meetings this week and the question is whether the spike in Covid/Delta infections, increased restrictions, and slowing in global growth will cause policymakers to hold off and maintain their current stance until recent uncertainties abate. As the BOC has already begun tapering, while the RBA is eyeing starting tapering this month another key question is raised on how the ECB  will respond and  how this week’s announcments from all these three major banks could impact the US Dollar. So far the BoC and RBA have managed to add further pressure on US Dollar with their tapering actions and remarks. Is the ECB next?

After the minutes to the last ECB meeting indicated that one of the arguments in favour of strengthening the dovish signal on rates was that this could reduce the need for the other instruments, there have been a number of Executive Board members flagging the possibility of an announcement of a slight tapering. The final decision on PEPP won’t be taken before December though, and President Lagarde is anticipated to play down the slight reduction in monthly asset purchase levels and focus on the very dovish guidance on rates and the fact that the ECB remains willing and ready to step up support again if needed. The updated set of forecasts meanwhile is likely to bring yet another upward revision to growth projections, with the economy now expected to reach pre-crisis levels by the end of the year.

EURUSD has more than reversed Friday’s spike as markets are reassessing Friday’s dollar-selling reaction to the August US jobs report. The pair has pegged a pullback at 1.1855 so far, having reversed out of Friday’s 48-day high at 1.1908. Taking a step back, it becomes clear that the pair is lacking overall directional bias, having for some months now been in an orbit of the 1.1900 level. This has been a debate of receding risk aversion, the Eurozone’s much lower interest rate and the ECB’s forcefully dovish guidance on the rate outlook, which continue to promote the EUR as a funding currency and keep a lid on the single currency, and on the other side the Fed’s success in keeping policy tapering expectations at bay being relevant here.

Hence the markets are focusing on any changes in the ECB’s stance before starting to factor which of the two economies performs better. As and when Fed tapering does start being factored, which we anticipate later in the year, this should impart a strong downside bias to EURUSD, with the ECB policy outlook likely to proceed with an announcement of a slight QE tapering following this Thursday’s policy review, though President Lagarde can be expected to downplay down the importance while stressing the central bank’s newly adopted “forcefully dovish” guidance on the rate outlook.

Overall, the longer-term risks remains to the downside for EURUSD, given the favourable expected US growth rate and the associated larger fiscal stimulus levels compared to the Eurozone.