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FX Update: A hawkish shocker from the ECB is a game-changer.

Forex 4 minutes to read
John Hardy

Head of FX Strategy

Summary:  The message from the ECB meeting today is that inflationary pressures in the EU are so great that now that they are far outweighing the economic outlook concerns raised by the war in Ukraine. Risk sentiment does not like the message, but the ECB really has no choice and has gone a long way to buying itself some credibility by waxing hawkish relative to expectations at a time of maximum pressure and uncertainty.


FX Trading focus: ECB waxes hawkish – a game changer.

I was convinced that the ECB needed at minimum to “buy some hawkish credibility”, at least via conditional guidance that promised a strong tightening once the new pressures and uncertainties from the war in Ukraine receded. Instead, the ECB decided that it simply couldn’t wait and moved forward already today with a more rapid schedule of QE tapering: to EUR 40 billion/per month in April, EUR 30B in May and EUR 20B in June, making it obvious that it “may end” its APP in Q3 (on that schedule, it would end after August), while also saying that it will (stick with orthodoxy and) only hike rates once balance sheet expansion has stopped. This sets up a rate hike at the September ECB meeting, in theory. The ECB reserved the right to retain maximum flexibility on all fronts. In reaction, the euro jumped and yields jumped far more: the German 2-year up some 10 basis points as of this writing and the 10-year Bund yield up a bit less than that. Italian BTP’s not happy with the more aggressive tapering schedule.

Strangely, I am not sure on what time frame this will offer the euro more support just yet, as growth worries and the divergent pressure on the EU from high energy prices and the potential further direct fallout from the war in Ukraine may continue to weigh. Indeed – the market recognized some risk of this development in recent price action and after bursting higher above 1.1100 in EURUSD, the pair was back flat on the day a bit later. Nonetheless, the move buys the ECB some credibility in not wanting to see a weak euro adding to inflationary pressures and it does help to draw a fundamental line of support in the sand as the ECB has moved in the direction of tightening at a time of maximum and historic pressure on real growth. This is tough stuff. And it is really a microcosm of the dilemma nearly every central bank faces: the only way out of the spiraling inflation hell here is via a demand-killing recession, with a mark down of financial assets also potentially providing additional braking on the economy via demand destruction.

As well, we may need to price in more for the Fed this year after this decision, something the market is already falling all over itself to do in recent sessions, with the somewhat odd notion that the Fed will only deliver 25 bps next week, followed by high odds of 50 basis points at the May meeting and most likely 25, but possibly more in June. Why on earth did Powell suggest he only leaned for a 25-bps move next week – to provide some margin for another hawkish surprise? The Fed will either go fifty or will do a hawkish 25 bps, making clear that one – or more – 50 bp hikes are possible from here. The US Feb. CPI was out just before this piece went live at 7.9% year-on-year as expected and up +0.8% month on month. Let’s recall that the most of the big ramp in commodities unfolded in the last days of February and over the last ten days.

By the way, Italy’s PPI hit 41.7% year-on-year in January, compared with 25% in Germany for that month – and that is before much of the further spike in commodities prices that unfolded starting in late February.

Note the SEK riding the stronger euro’s coattails and then some…shows what happens when the narrative changes.

Chart: EURUSD
Too early to call this one until the other side of the FOMC next week. A full technical neutralization of the sell-off in EURUSD requires a return to 1.1300 or higher, and the ECB has gone a long way to buy itself some credibility with today’s decision. But will this be felt immediately or more slowly in coming weeks? A tough call, but less tough to call that a bottom in euro crosses should be in here in EURUSD and perhaps EURCHF and EURJPY after today’s ECB game-changer.

Source: Saxo Group

Table: FX Board of G10 and CNH trend evolution and strength.
Merely providing an update for perspective – quite a momentum shift in the euro in recent days, and the ECB has bought itself some credibility today.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
Watching euro pairs here for whether comeback potential asserts immediately or only slowly in coming weeks – we have to get over the hurdle of the FOMC meeting next week as well….

Source: Bloomberg and Saxo Group
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