ECB Headache Now a Migraine after PMIs

Risk trading strategies found temporary relief overnight before the European session opened from the world’s second-largest economy. Better-than-expected Chinese manufacturing data has reversed some of yesterday’s market negativity that followed the weekend comments made by China’s Finance Minister Lou Jiwei who said his country would not amend its economic policies, despite the emergence of soft economic indicators lately. This morning’s reprieve was kickstarted by China’s HSBC flash manufacturing purchasing managers’ index (PMI). It’s the first gauge of activity in September, and the reading ensured China’s economy avoids falling into contraction, while overturning yesterday’s bearish sentiment that was on display closing out the U.S. markets.

Despite China’s flash PMI being marginally better (50.5 versus 50), the devil remains in the details. Among the notable components, new orders and export orders both increased at a healthy clip, but the employment component has decreased at an accelerated rate. However, the market remains wary of China’s property downturn, believing it remains the country’s biggest downside risk to growth. Despite giving risk a jumpstart, many believe that China needs to implement broad stimulus measures to support its economic activity. Hopes for a better-than-expected PMI reading would spurred material market relief that looked a tad too optimistic, now that diverging European PMIs have followed it.

France’s Economy in Dire Straits

Activity in France’s private sector has declined more rapidly this month (49.4 versus 50.3). This morning’s PMI survey suggests that the French economy remains close to, if not still, stuck in the stagnation that has prevailed over the first half of the year. This will only put President François Hollande under greater pressure. The French composite PMI fell to 49.1 from 49.5 in August, and while the manufacturing PMI picked up to 48.8 from 46.9, the services PMI fell to 49.4 from 50.3. For Europe’s second-largest economy, there is little sign of recovery in the medium term; with new orders declining leading to more job losses. In contrast to the weak French release, the German PMI has come in stronger. This month’s composite is at 54 compared to 53.7 in August with the breakdown revealing that a strengthening service sector helped to outweigh a weaker manufacturing sector. More importantly, the divergence is not just in the headline, but in prices too. The output prices in France have fallen further while Germany continues to show inflationary pressures. This scenario will turn a European Central Bank (ECB) headache into a splitting migraine. It implies that monetary conditions are too loose for the German economy, which will lead to German policymakers being averse to the ECB taking additional easing actions.

ECB’s Ongoing Deflation Problem

It’s not surprising that the eurozone composite flash PMI has come in weaker-than-expected with a reading of 52.3 versus the 52.5 print August, a nine-month low. The details revealed that both the manufacturing and services sector were fragile, despite firms cutting prices for the 30th consecutive month. This only highlights the ECB’s problems to stave off deflation. The weakening demand from Europeans shows the difficulties for the ECB’s monetary policy to gain traction. It’s no wonder eurozone policymakers would prefer that fiscal policies and structural reforms would play a more positive role.

EUR Momentum Builds

It puts into perspective ECB President Mario Draghi’s appearance before the European Parliament yesterday where he delivered a downbeat assessment of the eurozone’s economy. He indicated that growth of euro area real gross domestic product came to a halt in the second quarter, and that he expects inflation to remain at low levels over the coming months. This did not come as a big surprise to the market — how else is he ever going to justify the ECB’s easing measures? Again, Draghi reiterated the ECB’s willingness to use additional unconventional instruments, as well as stating that policymakers are ready to “alter the size and/or composition of said unconventional interventions if inflation remains too slow.” This would involve a plethora of additional policy tools, including government bond purchases, as well as making it more attractive to buy asset-backed securities, residential mortgage-backed securities, and covered bond purchases.

So far, the 18-member single currency is committed to a tightly contained range. The market continues to run into some resistance just north of €1.2880-85 with leveraged and real money sellers on the offer. While touted bids once again appear south of €1.2840-45, speculative accounts are said to be active on the buy-side. Market whispers have large options appearing throughout this week, rumored to total +€11B, if true, there is a strong possibility that the EUR’s range will be very much contained. Nevertheless, the longer the EUR wades into higher territory resistance at €1.2904 it is under threat. Evidence of a “slowing downtrend” has helped the single unit rally from a 15-month low at €1.2815 yesterday. The techies believe that the €1.2930 area remains pivotal.

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This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell