Federal Reserve and gloomy European news hammer Euro

Tom Tong05/Mar/2012Currency Updates

Currencies traded listlessly early in the week, in a trendless manner and with low volatility. That changed quickly Wednesday afternoon, when Ben Bernanke failed to make any mention of further quantitative easing in his testimony before the US Congress. Earlier that same day, the ECB announced that the take up for its new offer of unlimited liquidity had exceeded expectations at over 500 billion Euro. The Euro dropped sharply right after this news, and it continued to trend lower until market close on Friday. The continuous drip of awful macroeconomic news out of the Eurozone certainly didn’t help the common currency. Remarkably, this underperformance took place in a week where most risk assets managed to rally to new cycle highs. We regard this breakdown of the usual relationships as important validation for our bearish views on the Euro.


It was a fairly light week for data and macroeconomic and monetary policy news in the UK. Trading in GBP was driven mostly by news out of Europe and the US. Sterling held off surprisingly well against the dollar in the aftermath of Ben Bernanke’s testimony. In yet another breakdown of the usual correlations, it managed to end the week close to unchanged against the greenback. This of course meant it rallied sharply against the Euro, to end the week over 1.5% higher. Perhaps the most important piece of domestic news was the release of the PMI manufacturing sentiment index, which pulled back slightly to 51.2. This provides marginal support to our view of a further increase of 50 billion GBP in the Gilt purchase target for May. We remain somewhat surprised by Sterling’s ability to hold its own against the dollar, and would not be surprised to see a moderate pull back in the near term in this pair.


The Euro had a very difficult week, dropping sharply against just about every other major currency. The ECB announcement on Wednesday that a total of over 500 billion euros had been demanded by banks in its second offering of unlimited three-year loans. Soon afterwards, Bernake’s speech to the US Congress failed to make any mention of a further expansion of its quantitative easing target. The Euro dropped hard and fast on this news. The relative tightness of ECB policy vs. the Fed’s was perhaps the main support for the common currency, and this has now been completely reversed. The ECB will be expanding its balance sheet as the Fed keeps theirs constant.

The downward trend was helped along by the unending stream of negative economic data. The flash composite PMI index showed a drop below 50, consistent with a relapse into recession. Unemployment was a nasty surprise, rising to 10.7% against expectations of 10.4%. The freefall in Spanish employment is particularly worrisome. Net job destruction in February was -78,000, and the pace of job destruction over the last semester from already depressed levels is frightening. We continue to be amazed by the complacency of European authorities over the unfolding disaster, and maintain our negative view of the Euro.


US macroeconomic data were mixed last week, with a slight negative bias. Consumer spending is showing weakness, having posted almost no growth for three months. The highly volatile capital goods number showed a sharp drop, and the manufacturing PMI contradicted recent output data by dropping a couple of points. We take note of this weakness, but continue to think that the strength in the labor market will be sufficient to turn this recent downdraft in consumer spending into nothing more than a soft patch.


Written by Tom Tong

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