EUR Loses Foothold on the Cross

The 18-member single unit has managed to fall to a fresh two-year low outright this morning, briefly penetrating the psychological €1.26 handle (€1.2595), just as capital markets bid farewell to another volatile September and third quarter. Meanwhile, European equities are edging higher, trying to reverse yesterday’s decline ahead of the European Central Bank’s (ECB) next meeting on Thursday.

From a global perspective, the key to any defining rally or equity retreat currently lies with Hong Kong. Growing protests in the region are once again encouraging many investors to stay on the sidelines. Regional indices have wavered to the downside on signs that the standoff between the pro-democracy Occupy Central movement and the authorities will not subside any time soon. Ahead of the start of China’s National Day holiday, the Shanghai Composite and the Hang Seng have both been finding it difficult to maintain positive traction. Currently, Hong Kong’s Chief Executive Leung Chun-Ying is warning local businesses that protests may last for a long time, but he also noted there is no need to ask for deployment of the People’s Liberation Army. It’s been said China wishes to avoid repeating the bloody 1989 pro-democracy clampdown in Beijing’s Tiananmen Square. With a perceived lull in the standoff in Hong Kong, emerging market currencies are relatively quiet compared to yesterday. All the forex action is being driven by Europe.

Eurozone Inflation Falls to a Five-Year Low

Putting further pressure on the EUR this morning is the eurozone’s annual rate of inflation: it has fallen further below the ECB’s target in September to its lowest level in five years. The eurozone’s flash harmonized indices of consumer prices (HICP) have come in at +0.3%, which compares to a final reading of +0.4% in August. After the German HCIP surprise yesterday (+0.0% versus -0.1%), the headline number was expected. But more of an interest is the core rate of inflation; it has fallen to +0.7% compared to +0.9% — further weighing on the EUR outright and on the crosses (GBP and JPY in particular). Many believe that a result below expectations would be of particular interest to ECB President Mario Draghi and company, as inflation to them is the ECB’s official argument that might lead to quantitative easing. Nevertheless, a decline was mostly expected and is unlikely to prompt an immediate response from the ECB at its monetary policy meeting in Italy this week.

ECB policymakers are still expected to take some time to access the impact of the two waves of stimulus programs introduced last June (negative deposit rates, more credit, and purchases of asset-backed securities and covered bonds). Many forecasters do not anticipate the ECB to jump the gun as they believe the “base effect” (food and energy prices which are historically very low) will climb in October. Nevertheless, eurozone inflationary pressures are likely to remain soft for some time. Sentiment surveys released yesterday revealed that both businesses and consumers are more downbeat about their prospects in September than at any time since the end of last year.

So far, the initial market reaction to the softer inflation reading has both U.S. Treasurys and Gilt yields rising after declining during yesterday’s session. While eurozone debt yields are moving lower following the consumer-price index (CPI) data, European officials, especially the French, continue to express their content with a weaker EUR. It’s not surprising to see peripheral equity indices being supported by the weaker-than-expected core-CPI data.

The EUR Cross Sees Red

On the cross, the 18-member single unit continues to naturally underperform. Cable managed a kneejerk £1.6275 high after a +0.1% upward revision to the U.K.’s second-quarter gross domestic product (GDP) to +0.9% and then saw its subsequent low outright (£1.6194) as the market’s focus shifted to the bigger U.K. current-account deficit (-£23B versus -£17B expected or +5.2% of GDP). The pound’s break of the £1.62 handle was spurred by the EUR’s outright losses on the back of weaker inflation data. This has managed to push EUR/GBP to a 26-month low €0.77785. Asia’s low at £1.6225 is now cable’s resistance level, while the sterling bears will now be targeting £1.6162, the mid-September low, and £1.6052 (10-month low on September 10).

Yen Inches Up

USD/JPY has been trading heavy on Japanese fiscal year-end flows with many investors happy to lock in profits on USDs and Nikkei longs. Japanese investors are happy to pare back some of their global stock allocations. Meanwhile, Bank of Japan officials remain optimistic. Expect the market to begin to anticipate further measures only if September’s data happens to be weak as well. Currently, Japanese exporters are dollar sellers ahead of ¥109.75 and the highly profile ¥110.00 level. Japanese importers and investors have bids scattered ahead of ¥109.00. As to be expected, EUR/JPY (€138.20) is under pressure from the EUR’s outright move lower on the back of a weak eurozone inflation report.

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