Emerging markets bounce back, Euro rises as ECB fails to act
10/Feb/2014 • Currency Updates•
Last week saw a general rally in risk assets, and in particular those that had been punished the worst in the January dip: emerging markets stocks and currencies. In FX, the euro recovered its losses from the previous week against the dollar, as the ECB, contrary to our expectations, stood path on rates and failed to announce any significant measures to address deflation risks in the eurozone. Finally, Friday’s weakish US payroll report put further pressure on the dollar, which ended the week down against just about every major currency worldwide.
The Bank of England made no change to monetary policy and issued no statement, as was expected almost universally. The PMI business sentiment surveys came in somewhat weaker than last month, although the remain at levels consistent with the solid Q1 expansion we are expecting. In this news-scarce environment, sterling largely tracked the euro higher against the US dollar and most emerging market currencies, awaiting the most important news we expect this month: the publication next week of the Inflation Report. Since the unemployment threshold is all but dead, we expect that the PC will provide some sort of forward guidance. Most likely, it will join the growing club of Central Banks worldwide that publish an explicit projection of their expectations for the evolution of the intervention rate over time. The size of the gap between such expectations and market levels will be the key driver for sterling in the coming weeks.
We were disappointed in our expectations that the ECB would take further steps, after the sharp inflation surprise of the previous Friday. The latter left the eurozone rate at 0.7%, way below the ECB own rate, Further, the peripheral countries that can least afford it are all either close to or already in deflation. In response to this, Draghi merely told us that the situation is “complex” and warrants “further study”. We do hope the ECB completes its research project before the eurozone and/or the periphery is stuck in a Japanese-style spiral of deflationary expectations and falling prices, but are not holding our breath.
FX markets focused narrowly in the absence of further easing from the ECB and the mixed payroll report out of the US, and the euro recover the previous week’s losses against the dollar.
Like the first Friday of every month, investors were focused on the US January payroll report. The headline was weak for the second month in a row: just 113,000 jobs created in January, vs. expectations of about 175,000. However, the details paint a far more complex picture. Previous months were revised up by 34,000, which is enough to bridge half the gap to expectations. Further, the household survey, from which the unemployment rate is derived, painted a considerably more positive picture. Unemployment dropped 0.1% to 6.6%. Critically, this was accompanied by a rise in the participation rate; Fed officials have made it clear that they are watching this indicator as closely as the unemployment rate. Overall, we do not see enough in this report to change the Fed course and continue to expect another $10bln reduction in the pace of asset purchases at the next FOMC meeting.