Buy the Dip, as a Sustainable Drop in the Euro is Unlikely, According to SocGen
‘Printing money’ alone is unlikely to be able to weaken the euro – what’s necessary is a helping hand from the Fed or Brexit.
The use of what are known as non-standard, or unconventional monetary policy measures by the ECB and the BOJ have not been enough to weaken the euro or the yen, according to a recent research note by Societe Generales’s Alvin Tan.
Such policies include quantitative easing, when central banks print money for the purpose of buying bonds or IOUs from high-street or commercial banks, so that it can provide them with more liquidity or cash, with which to lend to businesses and households, to help stimulate the wider economy.
It also includes negative deposit rates, which are when central banks, which are like banks for banks, lower their interest rates to below zero so that banks saving or depositing money with them actually have to pay them for the privilege of looking after their money, in an effort to encourage them to withdraw and lend the money instead.
According to Tan such measures have spectacularly failed:
“The indirect attempts to weaken the exchange rate through asset purchases and negative rates appear to be hitting the proverbial brick wall. Neither the trade weighted euro nor yen has depreciated over the past twelve months, despite escalating unconventional monetary policies.”
He argues that the most theoretically persuasive technique to weaken either currency is via direct intervention:
“Theoretical work identified the exchange rate as an additional tool to ease monetary conditions when the lower nominal bound became binding. Neither the ECB nor BoJ have yet acted directly to devalue their respective currencies, as per some of the theoretical proposals.”
US Monetary Policy in Driving Seat
Tan suggests that the main fundamental driver for the EURUSD pair’s rate is American monetary policy as there has been, “a persistent negative correlation between EUR/USD and the US 10-year yield since mid-2013, when the ECB's refinancing rate dropped to 0.5%.”
The volte-face (turn-around) in the Fed’s intentions to hike rates, explains why the euro has failed to lose ground in recent months, perhaps more than any other factor.
The only sign of a possible re-tightening in the Fed agenda, came from a slightly more hawkish speech on Monday March 7, from Vice-Chairman of the Fed Stanley Fischer, however, this was slightly counterbalanced by Fed’s Brainard’s more dovish commentary on the same day.
Given there is little possibility of the Fed changing its stance to a more hawkish slant and announcing it in the days before the ECB meeting on Thursday, this is unlikely to be a factor in the EUR/USD exchange rate calculation around the time of the ECB meeting.
As such Tan argues that even if the ECB announce monetary policy which is an escalation in the non-standard response so far, this is unlikely to substantially weaken the euro for any length of time, and he concludes:
“Further easing is expected from the ECB this week but it is unlikely to push the EUR/USD exchange rate lower durably. We do not expect EUR/USD to break below the 1.04/1.05 low reached in 2015 over the course of this year, short of a Brexit scenario.”
One possible strategy response to Tan’s analysis is therefore to wait for the euro to fall and then buy the dip.
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