Euro Limps into the Weekend: Here's Why

It is not so much that the US dollar is building on yesterday's gains, though the greenback is firmer against most of the major and emerging currencies. Rather, it is more the case that euro and sterling are extending their downside corrections and this is serving to spark a broader short-covering advance in the dollar.

Recall that the market had gone into the ECB meeting yesterday with a clear bias that the central bank was likely to move in June after getting another, and arguably cleaner, inflation report, and updated staff forecasts. It was also understood that the ECB, like other central banks, does not really put so much weight into any high frequency data point that, moreover, is subject to revision. Instead, it was understood that the collegiate nature of the institution demanded greater effort on the part of Draghi to forge a majority.

Draghi must be pleased with himself. Despite the naysayers who clamor for action, once again the adroit central bank head was able to prevail by words alone. Draghi's performance managed to say nothing new, but managed to say it in a new way. The message that the ECB is alarmed by the persistence of low inflation has been delivered before, but, at the same time, part of the low inflation is understood to be a competitive adjustment in the periphery.

Some observers are emphasizing Draghi's phrase about the ECB being "comfortable taking action in June." Yet that too seems old hat. The issue is and has been so much if the ECB is going to act, it is what is it going to do. The answer to that lies with what the problem that it is trying to address. Some action does not necessarily mean buying government bonds or a imposing negative deposit rate. There are still a number of measures that the gradualist institution may explore first, such as cutting the 75 bp lending rate, formally stop sterilizing the highly profitable SMP purchases, cutting reserve requirements, cutting the repo rate, making it more competitive for banks to create ABS instruments, that the ECB may be willing to buy, to list a few that have been discussed.

The risk is that none of these measures would necessarily drive down the euro. It is true that many believe that quantitative easing weakens a currency. The economic theory is clear, but the practice is anything but. The SNB's QE was abandoned in favor of a direct currency cap. The BOJ was engaged in QE long before Abe and Kuroda, but the yen remained strong. On the Federal Reserve's real broad trade weighted index, the dollar bottomed in 2011. ECB easing monetary policy through conventional and/or unconventional means could spark more inflows into peripheral bonds and stocks and, demand for the euro. If there is a credit bubble forming somewhere is it there? The IMF has warned that the drop in yields may not be sustainable.

Technical factors also played a role. Initially,the euro rallied on Draghi's comments and dragged sterling up too. However, important psychological levels of $1.40 and $1.70 for the euro and sterling respectively held, and this stalled the momentum, forcing the late longs to exit. This snowballed.

Some disappointing data encouraged further selling of both currencies today. Following soft industrial orders and production data earlier this week, Germany reported a smaller than expected trade surplus. Exports fell for the second consecutive month. The consensus had expected a 1.3% increase in exports. Instead, they fell 1.8% on top of February's 1.3% decline. Imports fell 0.9%. The consensus expected a 0.6% increase after a 0.4% rise in February. Expectations for next week's Q1 GDP estimate may be shaved from previous forecasts of up to 1.0% growth. Some observers have been quick to blame the confrontation with Russia over Ukraine. We are less convinced. As we noted the sharp drop in foreign factory orders came from other EU countries.

Separately, the UK reported a 0.1% decline in industrial output and a 1.0% fall in construction output in March. We would not want to exaggerate the weakness of today's data. Manufacturing itself actually increased more than expected. The 0.5% increase compares with a consensus forecast of 0.3%. And the March trade deficit was smaller than expected. It is not so much that sterling was sold off; it is more than there did not seem to be a compelling reason buy it.

There have been a couple of other developments to note, though only one can be associated with the price action. That is the softer Norwegian CPI figures and counter-intuitively it has seen the krone strengthen against the greenback and euro. It is the strongest major currency on the day. The other development to be aware of is that Reserve Bank of Australia's Monetary Policy Statement. It did not break new ground, but if anything, it leaves one with the impression that rates are on hold for an extended period of time and that the full brunt of the economic headwinds of the end of the commodity-investment cycle has not been born yet.

The main feature of the North American session will be the Canadian employment data. The consensus calls for a 13.5k increase in jobs, but the key is the distribution between part and full time positions. The Canadian dollar has quietly been the best performing major currency this week, rising about 1.4% against the greenback coming into today's session. A weekly close below CAD1.0860 could spur expectations of a further decline in the coming period. The next target is near CAD1.0730, which corresponds to a retacement objective and near the 200-day moving average.