Sell EUR, GBP, NZD And AUD. Buy CAD, NOK, RUB And USD Here - SocGen

The ECB today announced that it was cutting the main refinancing rate by 5bp to 0%, cutting the marginal lending rate by 5bp to 0.25%, cutting the deposit facility rate by 10bp to -0.40%, raising monthly asset purchases by €20bn to €80bn from April, while also expanding the list of assets eligible for the programme to include non-bank investment grade corporate bonds (this adds €500bn or so to the universe they can buy), and finally introducing four new 4-year TLTROs...

We were looking for a bigger rate cut and were not expecting the increase in size and breadth of the asset purchase plan. It isn’t clear that the latter is negative for the Euro, if the result is to maintain confidence in European non-core Government and corporate bonds. Prior to 2015, ECB asset-purchases did nothing to encourage capital flight out of Euros, but merely persuaded investors to shift out of Bunds into, say, BTPs or Bonos. To that extent, a failure to break the psychological EUR/USD 1.08 level was not a surprise, though the bounce definitely surprised me, at least. The Bund/Treasury yields spread has remained little changed as 10- year yields have risen by about 6bp on both sides of the Atlantic (Chart 3).

The driver of the EUR/USD rally is clearly the move higher in shorter-dated European rates, with the 1y/1y rate up by a bit more than Bund yields. Can the ECB now engineer a fall back in 1y/1y rates to their lows (-25bp)? Can it engineer a move down in 10-year Bund yields, in absolute terms and relative to Treasuries? I think the answer to the first question may be ’No’ but the answer to the second is: ‘Probably, but only slowly and only with the FOMC’s help’.

We want to sell the euro at these levels, given that it has moved so far beyond what the correlation with rate differentials implies. And given that oil prices and the breakeven on US 10yr TIIPS are still in lock-step, we expect the FOMC tone to get gradually more hawkish again in the weeks ahead.

We also remain bullish of oil-sensitive currencies (RUB, CAD) and we’re still nervous of China-related currencies (KRW, TWD, NZD, AUD) as well as Sterling, where the Brexit debate is not getting any less juvenile. But the biggest challenge in G3 FX, in particular, is how to break down the negative correlation between oil prices (currently rising) and the broad US dollar TWI (currently falling). Can a less dovish Fed break this correlation and help get the dollar up against both euro and yen?

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