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Forget the Economy, Draghi Talks Down the Euro

Posted by Joseph Trevisani on Mar 13, 2014 1:49:00 PM

When it comes to influencing the currency markets, economic statistics cannot hold a candle these days to the pronouncements of central bankers.

This morning's U.S. retails sales were positive for the first time in three months. Last night Chinese industrial production saw the smallest annual increase in two and a half years.

Both February statistics might have been be expected, in their own way, to support the dollar. Retail sales because they point to the continuing reduction and eventual end of the Fed's quantitative easing program.  Chinese industrial production because it is the latest in a string of weakening data that indicate a rapidly slowing economy. When slipping production is combined with a falling yuan and turmoil in domestic credit markets you have the making of a safe-haven play to the dollar.

In fact neither release had more that the briefest impact on currency markets. After the Chinese release the euro lost five points and then gained 20. On the U.S issue the euro dropped 4 points and then recovered 10.

Compare that to the reaction to ECB President Mario Draghi's speech today in Vienna.

Mr. Draghi said that the ECB was ready to take "additional non-standard monetary policy measures" to fight deflation, and that forward guidance "creates a de facto loosing policy stance."  These are observations that he has made a least half a dozen times in various ways in the past months.   “At the same time, the real interest-rate spread between the euro area and the rest of the world will probably fall, thus putting downward pressure on the exchange rate, everything else being equal," he noted.

The policies that might turn his "loosening stance" into reality were rejected at last week’s governing board meeting. Two of the three policy suggestions, negative interest rates and asset purchases are thought to be forbidden by the German central bank and so not-starters. Even ending the sterilization of €175 billion in weekly sterilization of bond purchases, approved by the Bundesbank, was sidelined by the board.

Since last summer the U.S economy has steadily improved compared to the EMU and the Fed has moved, in Mr. Draghi’s word, to a de-facto tightening stance. The euro has gained 8.7 percent against the dollar in the past nine months and 2.8 percent since the beginning of February.

But as soon as the text of the speech became available the united currency nose-dived against the dollar. The euro fell 0.4 percent, from 1.3910 to 1.3852, having earlier reached 1.3967 its highest level since October 2011.

The ECB does not have another meeting until April 3rd. No one expects an emergency policy change in the interim.

In the assessment of central bank impact the initiative has shifted to the ECB.  Fed policy is set. Barring unforeseen developments, the reductions in quantitative easing will continue as long as the U.S economy continues to improve, no matter how slowly.

The ECB on the other hand, has two problems moribund economic growth and disinflation to which it has yet to find a policy antidote.

GDP has averaged just 0.23 percent on the quarter in the EMU since its recession ended last April. Annual inflation has averaged 0.8 percent for the past three months, the lowest non-recessionary rate in the history of the currency union.

President Draghi and other bank officials have made a determined effort over the past several months to convince observers that the bank retains policy options even as its 0.25 percent refinance rate is at the zero bound where interest rate policy ceases to be effective.

Of the two problems prices headed to deflation will elicit a policy response far quicker than slow economic growth.

No matter how remote it may actually be, a policy innovation from the ECB is still more likely than a change out of the Fed. 

And so the markets react to Mr. Draghi’s words even if they have heard them before and are probably just hot air.  

Joseph Trevisani

Chief Market Strategist

WorldWideMarkets Online Trading

Chart: Bloomberg





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