Currencies: "ECB Focus for Sure, but not Only Game in Town"

From Marc to Market:

The US dollar is trading broadly lower. The ECB meeting looms large. Many, like ourselves, expected that when Draghi said in July that the asset purchases would be revisited in the fall, it to meant after the summer recess, not a legalistic definition of when fall begins. Still, there have been some reports, citing unnamed sources close to the ECB, that have played down such expectations, and warn a decision on next year's intentions may not be announced until October or even December.

Such reports have helped steady the euro below $1.20. It traded above there only on one day (August 29). It had appeared that at the end of last week, the euro was heading there after the disappointing US jobs data, but was turned back by one of those reports citing anonymous officials. Despite the poor close last week (~$1.1860), the euro has recorded higher lows each day thus far this week and higher highs.

The ECB meeting provides new staff forecasts. The supposed leaks warn that GDP may be tweaked higher, but inflation shaved. Lowering inflation forecasts is more dovish than raising GDP is hawkish. Barring a hard stop, which has been dismissed as potentially disruptive, the ECB must extend its purchases. The evolving language of the ECB's statement suggests a tapering. We suggest that the consensus view of a reduction of monthly purchases to 40 bln euros for six months would be a dovish signal as it points to continued purchases in H2 18, while a cut to 30 bln euros would give officials flexibility to end the program at mid-year.

The failure of the ECB to make such an announcement today could spur pullback in the euro, but it may prove short-lived if the delay is just until next month. There is little doubt that Draghi will address the strength of the euro. And even if he discusses it in his prepared remarks, surely reporters will pepper him with questions about it at the press conference. Draghi, as other ECB officials have done, will likely recognize that part of the euro's appreciation is a function of better economic and political prospects in the euro area. We imagine he will also caution that continued appreciation could pose a headwind to the recovery.

There are two large euro options that expire today 90 minutes after Draghi's press conference starts. Based on DTCC data, there are nearly 730 mln euro struck at $1.1950 that will be cut today, and 920 mln euros struck at $1.20. The two-year high set at the end of August was $1.2070, and we have suggested the $1.2170 area as the next key target, which corresponds to a 61.8% retracement of the euro's decline from the mid-2014 high near $1.40.

Sweden's Riksbank seemed to pay no heed to the fact that the ECB may taper. It stuck with its dovish tone, suggesting no hike until the middle of next year. Its current asset purchase program is slated to continue until the end of this year. The dovish posture saw the krona ease. The euro traded to almost SEK9.55, a level it has not closed above since mid-August. Of note, the Riksbank announced it was shifting its preferred inflation measure from the headline to the underlying rate (CPIF) which excludes mortgage costs. There are no policy implications. CPIF rose 2.4% year-over-year in July, while the headline stood at 2.2%. On September 12, Sweden will report the August figures.

Only the New Zealand dollar is trading weaker than the krona today. The Kiwi has been underperforming. It is the only major currency that has lost ground (2.2%) against the US dollar over the past month. The key driver appears to be prospects that the September 11 national election leads to a new Labour government.

In the UK, Parliament will take up the Great Repeal bill today. It is the first reading. It is mostly theater. It is Monday's second reading that will be more dramatic. It is there that the cost of the loss of the Tory majority will be most acutely felt. The prospects for a longer transition phase than the Tories have pushed seem to have helped sterling this week. Yesterday it reached a one month high a little above $1.3080, which is also the 61.8% retracement of the down move since the early August high near $1.3270. Technical indicators suggest the odds favor a return toward the highs....MORE