Euro Falls as ECB’s Draghi Opens Door to More Stimulus

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Wall Street Journal

The euro fell sharply against the dollar after the European Central Bank raised the prospect it could ease further, putting more distance between itself and the Federal Reserve.

Remarks by ECB President Mario Draghi reinvigorated the belief that monetary policies in Europe and the U.S. were on diverging tracks. The ECB revised downward eurozone growth and inflation forecasts, and Mr. Draghi signaled that the central bank was ready to take steps, if warranted, to rouse the region’s dour economic fortunes.

That encouraged investors to place bets that the euro will weaken against the dollar, a trading strategy that had lain dormant for months.

Alan Robinson, a global portfolio adviser who helps manage $280 billion in clients’ assets at RBC Wealth Management, placed a bearish bet on the euro earlier in the week. His view was solidified by Mr. Draghi’s comments, which also highlighted worries about growth in emerging markets.

“It clearly underlined the different trajectories that the European economy and the U.S. economy are on right now,” he said. Recent U.S. data pointed to wage increases and steady growth, increasing the likelihood of higher U.S. interest rates. European data indicates the region is several steps behind the U.S. and may require lower rates for longer for growth to pick up pace, he said. Higher rates bolster a currency’s allure for investors.

Many investors and analysts say that Europe would be more vulnerable to any significant deterioration in China’s growth because of the Continent’s already-fragile economic situation and its trade ties with the world’s second-largest economy. Federal Reserve officials, meanwhile, have indicated that a rate increase remains on the table, although the recent market tumult has raised doubts about the exact timing of a move.

Bearish euro bets fell out of favor earlier this year as a recovery in Europe’s economy dovetailed with a soft patch in the U.S. After hitting a 12-year low against the greenback in March, the euro has strengthened.

In recent weeks, concerns about China have fueled big swings in stock markets and spurred many investors to exit from bets on other relatively risky assets, such as emerging-market bonds, that have been funded in euros. The rapid unwinding of these trades sent the euro to a seven-month high against the greenback on Aug. 24, when the Dow Jones Industrial Average plummeted as much 1,000 points in intraday trading.

Now, a growing number of investors and analysts say the euro is likely to resume falling against the dollar, a trajectory that could ripple through other markets. A strong dollar tends to exert downward pressure on commodity prices and presents a headwind for shares of large multinational companies, which garner a large portion of their revenues outside the U.S.

Since Aug. 24, the euro has slid more than 4% against the buck, to $1.1124 in late Thursday trading in New York.

The ECB meeting also raises the stakes on the U.S. August jobs report, due Friday, investors and analysts said. The data is expected to show continued improvement in the U.S. labor market, but a disappointing reading would likely upend euro bears.

It wouldn’t be the first time. From May 2014 through March, the euro depreciated 25% against the dollar, falling below $1.05 on March 13, after the ECB launched its €60-billion-a-month ($67.4 billion) bond-buying program. Following a raft of disappointing U.S. data in the spring, bets against the euro lost momentum. The number of net bearish bets has declined by 71% since March, according to weekly data from the U.S. Commodity Futures Trading Commission.

Some analysts caution that even if Friday’s U.S. nonfarm-payrolls report shows strong jobs growth, the Fed may decide to delay a rate increase if big swings across global markets persist in the next few weeks. That could put a floor under the euro. Economists are forecasting that the U.S. economy added 220,000 jobs in August, in line with recent gains.

Stanley Fischer, the Fed’s vice chairman, said late last month that the door remains open for a rate increase in September. But Federal Reserve Bank of Atlanta President Dennis Lockhart said on Aug. 28 that Fed policy makers will have to take into account worrisome signs across the global economy and the unsettled state of financial markets when they decide what to do at the Sept. 16-17 policy meeting.

Still, many market experts said the ECB’s move on Thursday to raise the limit on how much of a single bond issue the central bank could purchase underscored its commitment to its easy-money policies.

“Everyone was expecting them to sound dovish, no one was expecting them to do something as concrete as raising those limits,” said Steven Englander, Citigroup’s head of global currency strategy. The fact that Mr. Draghi also highlighted recent market gyrations and low inflation as a point of concern effectively raised “the market’s alert level,” he added.

“The ECB is more dovish and the risks that we have liftoff [in U.S. interest rates] sooner is higher than the market had been thinking,” Mr. Englander said.

The euro still has scope to strengthen against currencies other than the dollar, some investors say.

Despite its weaknesses, the eurozone’s economy is still stronger than that of many commodity-exporting countries. London-based Harmonic Capital has small bets that the euro will rise against the Australian dollar and the Norwegian krone, said portfolio manager Per Ivarsson.

“Growth expectations have fallen across the globe: That’s not unique to the eurozone,” Mr. Ivarsson said. “We’ll see volatility in markets as people move into safer and larger economies like Japan. But the euro could benefit from that, as well.”