Euro Short Covering Bounce Fizzles and Draghi Pushes it Lower

The US dollar is rebounding today after yesterday's correction.   Those losses seemed to have been a function of some profit-taking after the seeming confirmation in the FOMC minutes that the Fed was set, barring a significant surprise, to raise rates next month.  The dollar bulls were already beginning to buy the dip before Draghi spoke.  

Draghi escalated his rhetoric regarding future ECB action.  The market took Draghi's comments as a signal that the ECB will take aggressive action when it meets on December 3. The euro was sold back to yesterday's lows (~$1.0660) before a bid was found. 

Draghi said the ECB will "do what it must" to lift inflation as quick as possible.  He pushed back against ideas that the with the core rate at a two-year high (1.1%), there was no need for such urgency.  The central banks in Germany, Slovenia, and Estonia have argued against the need for new action.  Draghi is still pushing forward.  It is predicated on the staff cutting its growth and inflation forecasts.   

In his tenure, Draghi has more often than not surprised the market with his dovishness.  His comments today are important.  Taken together they suggest that Draghi is pushing the ECB toward broad based action.  There are four moving parts: pace, duration, composition and rates.  What participants are contemplating now is not tweaking one or two of these, but all of them.  Stepping up the pace of the purchases from the current 60 bln euros, to be extended beyond September 2016, including more agencies, and possible sub-sovereign instruments, and a cut in the deposit rate. 

Draghi's comment today that a lower deposit rate strengthens the transmission of the asset purchases, is the strongest signal to date that this is on the table.  Many people were looking for a 10 bp cut in the deposit rate, some 20 bp.  However, with the German 2-year yield at record lows near -40 bp, to really get ahead of the curve, a larger cut would be needed.  There is some speculation that the ECB may be considering a 50 bp cut.  In this environment, it is difficult to envision a sustained euro bounce between now and early December,  

ECB action may force the hand of other central banks, such as Denmark, with the Danish krone has been sold today too, and Switzerland.  The euro has been sold off against the franc.  The anticipated divergence between the UK and eurozone has seen the euro sold against sterling as well.   Today, so far, is the fourth session that the euro is testing the GBP0.6980-5 area.  A break of this would signal a test on the summer lows near GBP0.6950.   However, out medium-term target is the GBP0.6500 area that provided support in 2004-2006.  

The news stream from the US may be subdued ahead of the weekend.  There is no data of consequence (KC Fed manufacturing survey) and the two Fed officials that speak (Dudley and Bullard) are known quantities now.  Both are inclined to raise rates minus a surprise development. Yesterday's weekly initial jobless claims, the rise in leading economic indicators and the Philly Fed survey (November) all speak to the US economy demonstrating resilience to the numerous headwinds.   Although Q3 GDP is expected to be revised higher next week, Q4 appears to be tracking even stronger.  

Canada reports October retail sales and consumer prices today.  Headline retail sales are expected to eke out a small gain, but excluding autos, may have fallen by 0.4%, according to the Bloomberg consensus.  Economic activity is of greater concern to Canada that inflation.  Whereas many countries are wrestling with deflation pressures, Canada is not one of them.  Headline inflation is expected to rise 0.1% on the month and 1.0% year-over-year.   The core rate is expected to rise by 0.2% and for a 2.0% year-over-year rate (from 2.1% in September).  Disappointing retail sales may elicit a greater market response than a small miss on inflation.  

The Canadian dollar has strengthened about 0.2% against the US dollar this week, so far.  The main drivers are still suggesting caution.  WTI has not be able to get much distance from the $40 level.  The US-Canadian 2-year interest rate differential has drifted slight wider.  On the other hand, the rally in equities is somewhat supportive for the Loonie.  Initial support for the US dollar is seen near CAD1.3280.  The initial upside target is near CAD1.3340.