The euro made slow progress lower Thursday, even though the European Central Bank did not ease monetary policy as some expected and or hoped.
It was enough that ECB President Mario Draghi’s comments were deemed dovish or at least less hawkish than at prior meetings, and the pair soon came under downward pressure.
“It’s a perfect time to be short the euro and euro crosses,” said one U.S. trader.
“QE is much more of a possibility and Draghi’s comments were not as hawkish as before,” he said.
ECB President Draghi vowed Thursday that the Governing Council was “resolute” in its aim of providing an accommodative monetary policy for the euro area.
Speaking to the media during his regular monthly briefing in Frankfurt, Draghi also said that he and his colleagues were unanimously agreed on the need to use both conventional and non-conventional policy tools – including quantitative easing – in order to defend against both the risk of deflation and a “too prolonged” period of inflation.
Draghi said that “all instruments that fall within the mandate [of the ECB], including QE, are intended to be part of this statement. In fact as part of the discussion we had today was a discussion of QE – it was not neglected in the course of what was actually a very rich and ample discussion.”
In currency specific comments, he noted that, “The exchange rate is very important for price stability, so much so that we made an explicit statement in the introductory statement.”
“In this context, the possible repercussions of both geopolitical risks and exchange rate developments will be monitored closely,” Draghi said.
The ECB president stressed however that the euro level is “not a policy target,” explaining that “it is an increasingly important factor in our medium term assessment of price stability, but it is not a policy target.”
“In this sense we don’t link our medium term assessment with a precise level of the exchange rate, it’s part of the overall information that comes into play when we do our medium term assessment,” Draghi said.
The euro was trading at $1.3710 Thursday afternoon, on the low side of the day’s range of $1.3698 to $1.3805.
The pair topped out at $1.3967 March 13 (highest levels since Oct 2011) and came under pressure later that day on what was deemed “jawboning” remarks by ECB President Draghi.
At the time, Draghi noted that “The strengthening of the effective euro exchange over the past one and a half years has certainly had a significant impact on our low rate of inflation and, given current levels of inflation, is therefore becoming increasingly relevant in our assessment of price stability.
Subsequently, the euro succumbed to downward pressure, but has continued to find solid demand around $1.3700.
This demand is rumored to be driven by reserve diversification, hard to prove given that many central banks do not reveal the breakdown of their reserve holdings and traders, in the wake of recent FX scandals, have been even more tight lipped than usual.
IMF Currency Composition of Official Foreign Exchange Reserves or COFER data, released earlier this week, showed that total foreign exchange holdings stood at $11.7 trillion at the end of Q4 2013.
Of that total, $6.22 trillion were in allocated reserves, with a breakdown of $3.8 trillion (61.2%) in dollars and $1.52 trillion (24.4%) in euros. This compares to a dollar share of 61.7% and a euro share of 24.1% in Q3 2013.
The euro closed at $1.3527 Sept 30 and at $1.3743 Dec 31, 2013, suggesting that much of the increased euro share was due to valuation.
In Q4 2009, the euro share of FX reserves stood at 27.7% and the euro closed at $1.4321 Dec 31, 2009.
Credit Suisse strategists noted that this was the third consecutive rise in the euro’s share in global reserves, confirming that the previous crisis-driven drop “may have found a floor at 23.6% in Q1 2013.”
“Reserve flow support remains a risk to our EUR bearish view,” particularly as there appears to be a still significant euro shortfall compared to pre-crisis allocations, they said.
“The shortfall is particularly pronounced for EM reserves which could combine with a sustained solid reserve accumulation in EM (at least out of China) to support the EUR,” the strategists said reminding that “EM reserve growth has historically correlated well with EURUSD.”
On the ECB decision and press conference earlier, “the dovish talk from the ECB should anchor front-end rates,” they said.
“Further out the curve we expect yields to move higher in line with our view for a bottoming out of global inflation in coming months and improving cyclical data in Europe and the U.S.,” Credit Suisse said.
On the FX front, Draghi’s “reference to the potential use of unconventional measures tilts the policy bias further for EURUSD to move in line with our $1.36 three-month target,” the strategists said.
From a technical perspective, with the euro already breaking below its 55-day moving average ($1.3721 currently), the focus is on a move to the 100-day moving average at $1.3687.
Ahead of that, around $1.3693, is an important support trendline from last July.
A clear-cut break below $1.3685 would suggest scope for a return to the 2013 lows near $1.3477, seen February 3, traders said.
BOA Merrill Lynch’s monthly fund managers survey, released March 18, noted that a net 38% of managers said they were overweight eurozone equities in March.
This was up from 37% in February, a five-month low, but down from January, when a net 41% of those polled said were overweight eurozone equities and December, when a net 43% said they were overweight.
In addition, a net 56% of fund managers think the euro is overvalued, “the highest percentage since early 2011,” the survey said.
The survey was taken March 7 to 13, when the euro saw a $1.3834 to $1.3967 range.