Investors are bracing for an event heavy day. The highlight will clearly be the European central banks. However, the substantives information on monetary policy strategy path from this meeting is unlikely. We had originally penciled in a comments outlining the path towards normalization. The recent strength in Euro will keep the ECB focused on exchange rates and likely water down any discussion on extension of the Asset Purchase Program. While economic data has improved significantly in the EU, a slight delay to measure the market’s reaction to any Fed actions won’t meaningfully risk a surge in inflation outlook.
Yet, titillating the markets with hints of cutting QE purchases (even buffered with minimal extension) could send EURUSD back above 1.20. We don’t think Draghi will take the risk. There is a case that Draghi is only delaying the inevitable and should start announce an QE extension today to prepare the market for eventual trimming of size. Markets will likely dissect every sentence causing EUR vol to increase, but the longer-term outlook indicates that the ECB need to start tighten policy. The Euro has become less sensitive to short-end yield movements; beneficial yields spread will send EURUSD higher. Europe has enjoyed the benefits of a weaker Euro, judging from the improvement in German industrial production (4.0% from 2.7% y/y) exports will need to adjust to a strong Euro moving forward.
Yet, titillating the markets with hints of cutting QE purchases (even buffered with minimal extension) could send EURUSD back above 1.20. We don’t think Draghi will take the risk. There is a case that Draghi is only delaying the inevitable and should start announce an QE extension today to prepare the market for eventual trimming of size. Markets will likely dissect every sentence causing EUR vol to increase, but the longer-term outlook indicates that the ECB need to start tighten policy. The Euro has become less sensitive to short-end yield movements; beneficial yields spread will send EURUSD higher. Europe has enjoyed the benefits of a weaker Euro, judging from the improvement in German industrial production (4.0% from 2.7% y/y) exports will need to adjust to a strong Euro moving forward.
By Peter Rosenstreich
