Kathy Lien | Aug 21, 2019 20:17
The next 48 hours will be very important for EUR/USD because the currency pair has been confined in a narrow 60-pip trading range for most of the week. With Germany talking about potential recession in the third quarter and the Italian government in disarray, the single currency is struggling to find buyers. Yet the pair holds above 2-year lows because the market also expects an interest-rate cut from the Federal Reserve next month.
Investors are worried that US policymakers will shift their guidance at Jackson Hole this week, which is why they largely ignored today’s less dovish FOMC minutes. The dollar rallied briefly and gave up its gains quickly. When the central bank last met, they lowered interest rates by 25bp and according to the sminutes, most policymakers viewed the move as a “mid-cycle adjustment” and not the start of an extensive easing cycle. Some officials also expressed concerns that the market would view the cut as a negative signal about the state of the economy. All of this tells us that when the central bank lowered rates in July, they had no intention of doing more. If you recall, during his press conference Fed Chairman Powell talked about the economy’s resilience and the strength of the labor market.
However a lot has changed since then for the US, Eurozone and China. President Trump imposed and then delayed tariffs on China, raised the possibility of tax cuts then walked back from it this morning while Germany said they would increase spending if the economy falls into recession. The market had gone from pricing a 60% chance of one additional quarter point rate cut from the Fed this year to 100% chance of two rounds of easing by December. So far the Fed has not downplayed or confirmed this possibility, which is what makes Powell’s speech at Jackson Hole on Friday is so important. The world is watching this big meeting and he could very well take this opportunity to signal their intention to ease, reaffirming the market’s expectations. If that’s the case, EUR/USD could squeeze to 1.12 but if he’s noncommittal and Eurozone PMIs are weak, EUR/USD could break 1.10.
The first test for the euro will be Thursday’s PMIs. Economic data has been mostly weaker with the economy contracting in the second quarter, investor sentiment (as measured by the German ZEW survey) hitting its lowest level since 2010 and industrial production falling by the steepest amount since November 2019. There’s a very good chance EZ PMIs will come in softer, hardening the case for ECB easing and pressuring the euro lower.
Meanwhile, USD/CAD turned lower today following stronger than expected inflation data. Consumer prices grew 0.5% in the month of July, which kept the year over year rate steady at 2%. Unlike many other countries like Germany, where inflation is running well below target, Canada has been able to keep policy steady because price pressures have not fallen significantly. But inflation is not the only consideration for easing. The labor market is slowing and this Friday’s retail sales report will tell us how much of an impact (if at all) it has had on spending. If retail sales hold steady, it will shine a light on the relative performance of Canada’s economy but if it falls for the second month in a row, investors will start talking about rate cuts in Canada as well.
Written By: Kathy Lien
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