Euro After Draghi – Deutsche Bank
George Saravelos, Strategist at Deutsche Bank, lists down their conclusions from last week’s ECB decisions on EUR/USD.
Key Quotes
“First, the near-term case for further EUR/USD downside has weakened. The ECB shift away from further rate cuts has led to a significant repricing in European front-end yields removing a source of downside pressure on the euro. We wouldn’t over-emphasize the disappointment though. EU-US 2-yr real rate differentials have barely budged, with most of the Euro nominal yield move offset by higher inflation expectations as well as higher US yields. Rate differentials suggest EUR/USD is currently close to fair value.
Second there’s still a lot of easing in the pipeline. More government bond purchases and the inclusion of corporate bonds will raise the pace of ECB balance sheet expansion by a third compared to last year, similar to the BoJ. The expansion in liquidity faces further upside risks due to the new TLTROs: At extreme the pace could more than double to a global record high of 20% under full TLTRO2 usage. This would bring the ECB balance sheet to half of euro-area GDP compared to around a third last year.
Third, the ECB package has materially raised the odds of a more hawkish Fed. The Yellen reaction to foreign central banks depends on if they cause tighter (stronger USD) or easier (higher equities) financial US conditions. The ECB package was strongly skewed towards the latter, leading to a near-complete reversal of the US financial conditions tightening seen in Q1. With Fed PCE, unemployment and financial conditions projections not much changed from December, the risks turn back to a more hawkish Fed.
The change in ECB emphasis away from rate cuts leads us to push out our EUR/USD 1.00 forecast out to year-end from late-summer previously. But we’re not changing our overall directional bias and still believe the next big move in the euro is down.”
(Market News Provided by FXstreet)
