Monex: Hoe lang kan EURUSD rally nog voortduren?

March 10, 2020

Hieronder volgt een commentaar in het Engels van Ranko Berich, Head of Research bij Monex Europe op de recente eurosterkte. In de afgelopen weken heeft de euro sterk gepresteerd op de turbulente markten, met name ten opzichte van de dollar. De vraag is nu of de eurosterkte op korte termijn aanhoudt. Volgens Ranko Berich is het goed mogelijk dat als de ECB donderdag aanstaande de rente verlaagt en wellicht besluit het opkoopprogramma uit te breiden de euro aan kracht zal inboeten.

The euro has been one of the main beneficiaries of the seismic change in market pricing of coronavirus risk over the past two weeks. In the past month, markets have gone from expecting a modest shock to the US economy and a moderate global shock, to expecting a high probability of global recession and massive synchronised central bank response. This has meant that expectations of rate cuts and even QE from the Fed have built rapidly, narrowing the rate differential between the US and comparable large, safe economies such as Japan and Germany. The eurozone has been included in this basket for now, despite its well known economic vulnerabilities and the likely contraction in many of the area’s economies, especially Italy and Germany. In addition to narrower rate differentials, the euro has also benefitted from the unwinding of carry trades funded in the currency, but targeting higher-yielding emerging market fixed income. The total effect has been a powerful rally for EURUSD, which is up almost 7% from February’s lows.

Looking ahead, there is still potential for further US dollar weakness driven by expected or actual, monetary easing from the Fed, but the scope is diminishing simply because of how low the recent falls have taken OIS (Overnight Index Swap) and Treasury yields. For instance, OIS markets are pricing in more than 90 basis point of cuts from the FOMC by the April meeting, a move that would take the Federal Funds rate to its effective lower bound. Treasury yields have also plummeted. Two-year yields are less than 20 bps above all-time lows achieved during the Fed’s asset purchase programme in 2011. Although further falls are possible, the rate of decline may slow in the near term until more information about the effects of the virus on the global economy, or the FOMC’s thinking, is available.

This leaves the ECB and the eurozone economy as the single most important factors that may take the edge off the euro’s recent strength. Given the tightening in eurozone financial conditions and the dire state of several important eurozone economies, such as Germany and Italy, the ECB will certainly cut interest rates at this week’s meeting. The question is how much further Lagarde and her fellow Governing Council members will be able to go. Bringing EURUSD back below 1.10 is likely to be beyond the writ of any measures the ECB will be capable of deploying in the near term, but if the ECB decides to deliver an expansion in asset purchases, some of the recent edge could be taken off the EURUSD rally.

What to look out for on Thursday’s ECB meeting:

•A 10bp rate cut has been almost fully priced in by OIS markets, and we believe the ECB will deliver this measure, even if its marginal effectiveness in stimulating the real economy may be low. There is also a chance of over-delivery here, aimed implicitly at preventing further euro appreciation. Holding rates unchanged would further tighten financial conditions, which have contracted due to falls in equity prices and widening spreads between sovereign debt and interbank lending rates. The euro has also appreciated significantly in recent weeks, and a hawkish surprise would exacerbate this move.

•The ECB is also likely to take additional measures to support lending to non-financial corporates. These measures may include attempts to encourage banks to increase lending, such as increasing the amount of reserves exempt to the ECB’s lowest deposit rate, and measures to broaden the uptake of targeted long term refinancing operations.

•Expanded sovereign asset purchases are not likely to be used at this meeting, but cannot be ruled out. The ECB’s current asset purchase programme is constrained by the issuer limit, and the capital key. Loosening either would cost Lagarde political capital that, in our view, would be better spent making calls for fiscal spending. An increase or change in the eligibility of corporate bond purchases seems at least likely, however, and may offer a means by which the ECB can exceed market expectations.

•Finally, Thursday’s meeting has the potential to feature the most open calls for fiscal easing of any central bank in recent history. Mario Draghi’s final press conference last year already featured tacit acknowledgement that monetary policy had limited capacity to lift growth in the eurozone. Calls for fiscal policy to “do its part” have long featured in ECB communication. Lagarde could take these calls a step further by openly acknowledging the ECB may not be able to fully offset the incoming shock to growth, and call for fiscal measures to do so.