Below I present a possible scenario of events for the currency pair EUR/USD during the meeting the ECB by investment bank Goldman Sachs (GS)
The central expectation of Goldman Sachs' European economics team remains that the ECB will this week cut the deposit and MRO rates by 15 bp. They do not believe in a game changer like QE because they see HICP inflation bottoming out in March and then rising to 1.8% in 2016, 3/10ths above the ECB forecast.
But given that recent commentary around QE has clearly grown and some argue that this is clearly what “should” happen, GS discusses in a recent note to clients all the ECB potential easing steps and their impact on EUR/USD.
GS estimates that:
1- A complete end to SMP sterilization could see the Eonia fixing fall around 6-7 bp, with longer-dated rates rallying a bit less.
"We think the instantaneous impact on EUR/USD would be quite small, around half a big figure," GS projects.
2- A deposit and MRO rate cut of 15 bp could see EUR/USD react more.
"We think that the instantaneous drop would be no more than one-and-a-half to two big figures given our estimated sensitivities. Of course, this range is subject to great uncertainty, given the lack of historical precedents (certainly for such a large currency area) and the potential for asymmetry as the deposit rate goes negative," GS adds.
3- Any indication that sovereign asset purchases by the ECB are imminent would be a game changer for EUR/USD.
"That is because we see the main support for EUR/USD coming from flows into periphery assets, notably stocks and bonds. The only way to “discourage” these inflows is to make the underlying asset expensive, thereby discouraging inflows. We think QE from the ECB would discourage foreign inflows into the periphery and help turn the direction of EUR/USD. We see ECB purchases of private assets, like bank loans, as an extension of sovereign bond purchases, with a similar conceptual downward effect on EUR/USD," GS argues.
"In conclusion, we think only QE holds the promise of materially impacting EUR/USD and reversing its trend rise. Neither SMP sterilization nor a deposit rate cut have, in our opinion, the potential to do that, though they may naturally enhance the ECB’s forward guidance and act as a drag on EUR/USD as US data pick up," GS adds.
"In practice a lot depends on communication, of course. For example, if there is an ECB deposit cut and President Draghi uses the press conference to emphasize that there could be a lot more similar easing measures, this could signal a swifter move to unconventional territory and could see EUR/USD fall more. In contrast, if any easing is talked about as a one-off measure, the instantaneous impact on EUR/USD could be less, and quickly reversed. In addition, it is possible that the effect on Euro area rates could spill over into US interest rates, in which case the effect on the interest differential would be less," GS argues.
What about if the ECB does nothing this week?
"The EUR would most likely rally on the heels of no action. Front-end rates could play some catch-up with the US, particularly in 2-to-5-year maturities," GS answers.
1- A complete end to SMP sterilization could see the Eonia fixing fall around 6-7 bp, with longer-dated rates rallying a bit less.
"We think the instantaneous impact on EUR/USD would be quite small, around half a big figure," GS projects.
2- A deposit and MRO rate cut of 15 bp could see EUR/USD react more.
"We think that the instantaneous drop would be no more than one-and-a-half to two big figures given our estimated sensitivities. Of course, this range is subject to great uncertainty, given the lack of historical precedents (certainly for such a large currency area) and the potential for asymmetry as the deposit rate goes negative," GS adds.
3- Any indication that sovereign asset purchases by the ECB are imminent would be a game changer for EUR/USD.
"That is because we see the main support for EUR/USD coming from flows into periphery assets, notably stocks and bonds. The only way to “discourage” these inflows is to make the underlying asset expensive, thereby discouraging inflows. We think QE from the ECB would discourage foreign inflows into the periphery and help turn the direction of EUR/USD. We see ECB purchases of private assets, like bank loans, as an extension of sovereign bond purchases, with a similar conceptual downward effect on EUR/USD," GS argues.
"In conclusion, we think only QE holds the promise of materially impacting EUR/USD and reversing its trend rise. Neither SMP sterilization nor a deposit rate cut have, in our opinion, the potential to do that, though they may naturally enhance the ECB’s forward guidance and act as a drag on EUR/USD as US data pick up," GS adds.
"In practice a lot depends on communication, of course. For example, if there is an ECB deposit cut and President Draghi uses the press conference to emphasize that there could be a lot more similar easing measures, this could signal a swifter move to unconventional territory and could see EUR/USD fall more. In contrast, if any easing is talked about as a one-off measure, the instantaneous impact on EUR/USD could be less, and quickly reversed. In addition, it is possible that the effect on Euro area rates could spill over into US interest rates, in which case the effect on the interest differential would be less," GS argues.
What about if the ECB does nothing this week?
"The EUR would most likely rally on the heels of no action. Front-end rates could play some catch-up with the US, particularly in 2-to-5-year maturities," GS answers.
Another investment bank Citi still holds EUR/USD Short:
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| pic. 1. Citi -77 pips EUR/USD |
This is what scares the Fed & This is what scares FX market most - opinion Deutsche Bank
"There is nothing that scares the Fed more than losing control over the back-end of the curve. The last few tightening cycles show that a better way for the Fed to avoid back-end yields from overshooting is for policy to be proactive at the front-end. As the Fed slowly evolves toward this conclusion, history shows the associated front-end led bear flattening, should prove significantly more positive for the USD versus majors, than the recent curve flattening between the 5 year and the back-end, but steepening from the front-end through the intermediate sector. „
With positioning much cleaner, we expect an orthodox currency response to data this week i.e. USD up on stronger than expected US numbers. A short basket of JPY, SEK and CAD is preferred to avoid being caught out by any individual currency idiosyncrasies. Note however that US short-term rates are not at levels that have definitively changed relative funding costs among the low yielders, and back-end yields are not at a point that will mitigate against duration risk, suggesting follow through from real money into the USD will remain restrained for the time being
Nothing scares the Fed more than a bond market overshoot. Nothing would scare the markets more than a USD that does not get at least a temporary lift from more definitive evidence that the weather was a major US data depressant in the last few months. While strong FX follow through to decent US data is unlikely, we are not at the point where the USD will not respond favorably to strong data against most currencies."
Alan Ruskin, macro strategist - Deutsche Bank
With positioning much cleaner, we expect an orthodox currency response to data this week i.e. USD up on stronger than expected US numbers. A short basket of JPY, SEK and CAD is preferred to avoid being caught out by any individual currency idiosyncrasies. Note however that US short-term rates are not at levels that have definitively changed relative funding costs among the low yielders, and back-end yields are not at a point that will mitigate against duration risk, suggesting follow through from real money into the USD will remain restrained for the time being
Nothing scares the Fed more than a bond market overshoot. Nothing would scare the markets more than a USD that does not get at least a temporary lift from more definitive evidence that the weather was a major US data depressant in the last few months. While strong FX follow through to decent US data is unlikely, we are not at the point where the USD will not respond favorably to strong data against most currencies."
Alan Ruskin, macro strategist - Deutsche Bank
best regards,
oscarjp
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