Swissquote Bank: Hawks’ return

Swissquote Bank: Hawks’ return

Outlook Central bank Fed
Outlook vooruitzicht (4).png

By Ipek Ozkardeskaya, Senior Analyst at Swissquote Bank

Major US indices were offered on Wednesday, as Nasdaq recorded its biggest drop in two weeks. But the retreat wasn’t anything more serious than a meagre 0.57%, as the S&P500 retreated 0.13%.

Rising COVID-19 worries and the Federal Reserve (Fed) tapering expectations have been denting the investor appetite for the past couple of sessions, though Nasdaq is consolidating above its one-year positive trend top, as FAANG stocks give no sign of stress with Netflix hitting a new record, Amazon recovering July losses, Facebook, Apple and Amazon consolidating near their all-time-highs despite antitrust news.

Activity in European and US futures hint that we may not see the mood improving before today’s ECB verdict and Friday’s US producer price data which may have advanced to 8.2% in August from 7.8% printed a month earlier, with a chance of seeing a negative surprise – higher PPI. And a strong acceleration in PPI should further revive the expectations of a Fed taper sooner rather than later and weigh on the market sentiment, but most of the Fed hawkishness is already priced in and doesn’t represent an important risk per se.

The major risk is that there are many leveraged positions in the market right now, and even a fall as small as 2% could trigger forced liquidations and amplify a downside correction. Now it’s Europe’s turn to find out more about what’s cooking in the European Central Bank’s (ECB) kitchen.

The European Central Bank is expected to maintain its rates unchanged at today’s meeting, and at many more meetings to come, but they are expected to start talking about tapering their bond purchases. And the potential taper talk doesn’t necessarily please investors, as the Covid situation remains uncertain and European businesses need the ECB’s support to go through what might be another dark winter.

The DAX shed some 1.50% yesterday and the CAC40 was down by 0.85% ahead of today’s ECB meeting as some investors are now fearing the vindictive return from the ECB hawks!

One of the reasons why the ECB hawks are coming back in charge is the rising inflation. The European CPI hit the 3% mark in August. The latest jump in CPI boosted fears among the inflation-sceptic member states such as Germany, Austria and Netherlands who started calling for tapering of the ECB’s asset purchases sooner rather than later.

The question is when and how? I believe that the divergent opinions at the heart of the ECB won’t let the bank make any sharp move in the close future. We would most probably see the ECB slowing its PEPP purchases, but a reduction in the total size of the pandemic program, a change in regular APP or a rate normalization are highly unlikely.

Today’s meeting will give away some insight about how the ECB will cope with the rising inflation and the stressed hawkish members, what the dovish-hawkish balance will look like and where the euro should be headed next. The chances are we will see President Christine Lagarde soothing the doves’ nerves at today’s press conference – which should trigger some weakness in euro versus the greenback in the short run.

But whatever happens, the rising inflation threat will likely cap the downside potential in the EURUSD in the coming weeks and keep the euro on track for a recovery to the 1.20 mark against the US dollar.