The European Central Bank meeting next Thursday will indicate the end of asset purchases. Council members say that if inflation remains stable, bond buying should be taper. We think that markets are focused on the pure economic data. However, the ECB decision is more practical than fundamental, because Quantitative Easing has expanded its balance sheet to destabilizing heights. ‘Moral hazard’ has increased, as highlighted by the recent Italian political chaos. The ECB wants to avoid owning more than one-third of any nation’s sovereign debt, which after years of buying is coming dangerously close. Stealth ‘debt mutualisation’ in the Eurozone is really happening. Moreover, the ECB wants to reclaim its tools. With a bloated balance sheet and negative rates, the bank has few policy options, should Europe hit a shock. Just as the US Federal Reserve in 2013 saw normalization not just as a function of economic data, so now does the ECB.
Ending QE does not necessary mean higher interest rates, which are expected to come 6-8 months after ECB completely tapers. We remain constructive on EUR/USD as the US rate hike cycle is nearing the end while ECB is nearing the start. We see the current 1.1765 as a good position to reload strategic longs.
By Peter Rosenstreich