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FX Update: Brutal jump for Euro after ECB capitulates.

Forex 6 minutes to read
John Hardy

Head of FX Strategy

Summary:  The ECB effectively capitulated yesterday, as markets front-run the ECB intent to review its policy on inflation at the next ECB meeting as a sign that powerful quantitative tightening followed by rate hikes as soon as July are in the cards. The euro reset sharply higher, but may fail to find much follow-on momentum on this development. Focus today switches today to the US jobs report for January, where earnings may get more focus than a likely negative payrolls growth due to temporary covid effects.


FX Trading Focus: BoE fails to impress after hawkish headlines. ECB capitulates.

Bank of England: hawkish headlines, less hawkish press conference. The Bank of England narrowly missed voting for a 50 basis point rate hike yesterday, instead going for the expected 25 basis point move to take the policy rate to 0.50% on a vote of 5-4. On the balance sheet signaling, the Bank indicated that it will not replace maturing Gilts (government bonds) and will outright begin to sell Gilts once the policy rate has reached 1% at a stable and predictable pace. The Bank also said it would seek to rid itself of its corporate bond holdings over time.

Far less hawkish than the narrow decision to not move 50 bps at this meeting was the Bank’s new set of economic forecasts, which suggest mounting stagflationary pressures, as inflation for the coming year was revised up sharply, while growth was revised down to 1.8% from 2.1% for the 12 months ahead. The policy forecast for the year ahead was nudged 30 basis points higher from the November level.

And in the press conference, Governor Bailey sounded far less hawkish than the initial headlines suggested, as he fretted the uncertainty of energy prices and their effect on the outlook. Bailey made a terrible gaffe by suggesting that workers, who have suffered one of the worst modern drops in real incomes due to inflation, shouldn’t ask for large wage increases. Sterling initially rallied on the hawkish headlines, and a solid pull higher in UK short yields did held, but the rally quickly ran out of steam versus the US dollar and was brutally reversed against sterling on the ECB meeting developments discussed below. The EURGBP rocket launch yesterday was especially significant technically as discussed below.

ECB opens the door to policy review and opens the floodgates to short euro covering. The ECB’s initial policy statement appeared to show that the central bank was standing firm on its intent to maintain the current policy rate through this year as it announced a schedule of slowly tapering asset purchases this year, with rate lift-off not to arrive until balance sheet expansion was halted. Initially the euro actually sold off, but later began to rally as it was noted that the new ECB statement dropped the two-way potential for rates: i.e., the reference to keeping the rates at current levels “or lower” was dropped. But the eureka moment was in the press conference, when President Lagarde indicated that the ECB will use the March and June meetings to reassess its outlook on inflation, a move that the market saw as certain to lead to a capitulation on its formerly resolutely dovish stance and the need to bring forward rate hikes.

European short rates, already on the move as the market was bidding up the potential for the ECB to cave on inflation, soared further and took the euro sharply higher as the market moved to price in a series of ECB rate hikes, beginning as early as the June or July ECB meetings. For perspective on the scale of the move a bit further out the curve, the June 2023 Euribor contract sold off a massive 20 basis points yesterday – a monster move.

The action in euro crosses was equally sharp, with the euro sharply higher across the board. The move was particularly jarring in EURGBP, which had tried to sell off to new lows on the initial hawkish read of the BoE meeting. Indeed, the flood gates were opened as this was an almost binary move. From here, I would expect the price action/upside potential for the euro to slow sharply as we can hardly expect ECB rate increases to keep pace with other central banks in a global hiking cycle, particularly as the euro – always an important focus for the ECB since Draghi – has already moved sharply.

As we discussed on this morning’s Saxo Market Call podcast, it will be extremely important to track the Core-Italy yield spreads from here. Can this avoid blowing significantly wider once the ECB withdraws its bid from the EU sovereign bond market? Given that the ECB wants to taper purchases before hiking rates, a brutal taper potentially lies ahead if the July meeting is meant to be the lift-off meeting for the policy rate. Good luck with EU solidarity when the economy has become a stagflationary slog – this will likely crop up on the political radar very quickly in the months ahead. The Germany-Italy spread widened sharply to 150 bps yesterday to its highest since the months around the pandemic outbreak in 2020. Once yields go above a certain level, whether in the US or in Europe, the ECB and Fed will have to step in to cap rates, but that would require a political order to do so and is getting ahead of ourselves.

Chart: EURUSD
A huge rally yesterday in the euro across the board, and the EURUSD has gone very far very fast. As noted above, I suspect we have seen a “binary moment” here on the ECB’s capitulation. The ECB will drag its heels on hiking rates relative to other central banks if we are set for a sustained hiking cycle. But the move has put an emphatic bottom on the chart regardless. Upside resistance after the local 1.1482 pivot high is the prior major lows below 1.1700 and perhaps the 200-day moving average falling below that level, with support at perhaps 1.1400 now.

Source: Saxo Group

Today, I will focus on how the market treats today’s US January jobs report, particularly US long treasuries, which perked up again on the powerful lifting in European yields. The US 10-year Treasury benchmark yield is only about eight basis points below the cycle high of 1.90%. Will the market write off a likely negative payrolls print (due to omicron disruptions) and consider the wage-price spiral narrative if average hourly earnings surprise strongly to the upside?

Table: FX Board of G10 and CNH trend evolution and strength.
A massive boost in EUR pairs shows clearly with the NOK trying to hang on to the Euro’s tails. Interesting to watch whether SEK can catch a more significant bid over the coming week on the euro strength and the Riksbank next Thursday.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
The action limited to euro pairs, with the euro now in a positively trending clean sweep after yesterday’s action, save for against NOK. Elsewhere, watching whether the USD uptrend holds against the Aussie, CAD and NZD after the recent reversal in USD strength, while GBPUSD looks pivotal if it doesn’t follow through higher soon.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights (all times GMT)

  • 1330 – US Jan. Nonfarm Payrolls Change
  • 1330 – US Jan. Unemployment Rate
  • 1330 – US Jan. Average Hourly Earnings
  • 1330 – Canada Jan. Unemployment Rate
  • 1330 – Canada Jan. Net Change in Employment
  • 1500 – Canada Jan. Ivey PMI

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