After falling sharply against the US dollar today, the euro is headed lower. Investors sold euros aggressively after the European Central Bank announced a new targeted long term refinancing program. EUR/USD dropped to its weakest level in 17 months and has not see one positive day since February 26. Today's move took the pair below 1.13 and 1.12, an important resistance turned support level back in the summer of 2017. We expect further losses in the euro and whether that happens tomorrow or next week hinges on Friday's US non-farm payrolls report. If the US jobs number is stronger, we should see a swift move to 1.11 followed by a push towards 1.10. If the US jobs number is weak, we'll see a relief rally that will certainly invite sellers.
If you read my note yesterday, I talked about how the ECB was widely expected to roll out a new TLTRO program in order to maintain funding conditions after the current loans fall under the 12 month maturity mark in June. However, the timing and the details of the announcement were less clear. Today's actions tell us that the ECB felt they could wait any longer with growth slowing and price pressures easing. The loans would begin in September and have a 2-year maturity. They are aimed at boosting inflation and preserving favorable loan conditions. The central bank also drastically cut their 2019 growth and inflation forecasts. Instead of rising 1.7%, they now expect the economy to expand by only 1.1% this year. Instead of rising 1.2%, they expect CPI to grow by 1.2%. 2020 and 2021 forecasts were also lowered but not by such a large magnitude.
The nail in the coffin for the euro was the change in forward guidance. The ECB sent a powerful signal to the market by saying that rates will remain at their present levels through the end of 2019, instead of just the summer.
With Italy in recession, Germany flirting with negative growth, Britain at risk of a no-deal Brexit and the global economy slowing as a result of protectionism, the central bank felt that it was absolutely necessary to renew their TLTRO program and provide additional accommodation to the beleaguered economy. Not every part of the Eurozone is performing poorly though - French growth is holding steady and Spain is enjoying the strongest growth of the big 4 euro economies. However with car tariffs looming, that's simply not enough for the ECB because in Draghi's words, the risks to the economic outlook are still tilted to the downside. Even with another TLTRO program, the central bank's actions can't stop the impact of protectionism or a disruptive Brexit. These are bandaids on a wound that could worsen quickly.
German 10 year bond yields have fallen to its weakest level since 2016 on the back of the ECB's actions and with a yield of less than .1%, it will be tough to attract investors. The last time German yields were at these levels, it was right before EUR/USD dropped from 1.12 to 1.10 and later to 1.04. The euro is headed lower and the question of how much it falls depends on how much strength there is in the US labor market.
US non-farm payrolls are scheduled for release on Friday and there's no question that job growth will be slower in February compared to January. The 304K increase at the start of the year was much stronger than expected and there's a very good chance that it will be revised lower as a result of the government shutdown. ADP also reported weaker job growth and the employment component of non-manufacturing ISM fell to its lowest level in 8 months.
Yet it won't take much for the labor market report to be good for the USD and negative for EUR. As long as non-farm payrolls growth exceeds 160K in February and the revision to January keeps it above 200K, investors should be satisfied. The number to watch twill be average hourly earnings. According to Fed's Beige Book, a number of districts reported a tight labor market and notable worker shortages. This leads us to believe that wage growth will pick up in February. If average hourly earnings growth is 0.3% or better and NFPs rise by 160K or more, EUR/USD will be on its way to 1.10.
Here's a look at some of my favorite leading indicators for NFP
Arguments in Favor of Stronger Payrolls
- Consumer Confidence Index Hits 18 Year High
- University of Michigan Consumer Sentiment Index Rises
Arguments in Favor of Weaker Payrolls
- ADP Falls to 183K from upwardly revised 300K previous month
- Employment Component of Non-Manufacturing ISM Drops to 8 Month Low
- 4 Week Jobless Claims Rises to 229K from 220K
- Continuing Claims rise
- Employment Component of Manufacturing ISM Declines Further