Euro Drops As ECB Expected To Cut Rates Further

Talking Points

• Japanese Yen: Japanese Holiday Mutes Price Action
• Pound: Brown Unveils Plan For Labor Market
• Euro: Sinks As ECB Expected To Cut Rates
• US Dollar: Price Action Dictated By Risk Winds

Euro Drops As ECB Expected To Cut Rates Further

The Euro fell nearly 400 bps during overnight trading as markets started to price in an expected ECB rate cut on Thursday. An empty fundamental calendar put the week's most significant event risk in full focus and the expectations that the central bank will lower its benchmark rate by 50 bps led to a sharp sell off in the Euro. Additionally, comments from International Monetary Fund's Managing Director Dominique Strauss-Kahn raised the prospect for more easing from the ECB, when he said Europe is 'underestimating the needs' of fiscal stimulus for the economy. The single currency would fall to as low as 1.3325 before finding support.

Despite the concerns of President Trichet that bringing interest rates too low too soon will trap the MPC and leave them without recourse in the future, markets are expecting that the weakening economy and falling prices will force the MPC to ease further. Credit Suisse overnight index swaps have went from pricing in 52 bps of cuts over the next twelve months to 184 bps in the past two trading days as expectations that the current recession will deepen. We could see the Euro/ Dollar pair looks to test the 100-day SMA at 1.3233 with a break there leaving psychological support at 1.3000 as the next hurdle. However, the Euro's gains against the Pound today demonstrate that there is support out there for the currency which could prevent further losses.

The Pound weakened against the dollar and the Euro despite Prime Minister's Gordon Brown's pledge of £500 million to encourage hiring. The plan will look to increase support for anyone still unemployed after six months as concerns mount that the current recession will continue to weigh on hiring. The lack of any significant fundamental data will leave the Sterling trading off of Euro and Dollar sentiment for the week which could lead to a rebound versus the single currency and further weakness against the dollar.

An empty U.S. calendar will leave price action at the mercy of the broader macro themes with the dollar possibly benefiting from growing concerns over the global economy. As the prospects for a rebound in 2009 dwindle, we are seeing the carry trade unwind and a renewed flight to safety. Yet, the lack of dollar/ yen price action cast some doubt on the risk aversion play. However, a holiday in Tokyo may explain the lack of interest in the pair. Now that NFP's are in the rearview mirror and the ECB rate decision lies ahead, markets may start to focus on weakness outside the U.S. which could lend dollar support throughout the week. However, a possible joint venture between Morgan Stanley and Citigroup could spark risk appetite and lead the green back lower.

DailyFX

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