FX Update: Can ECB meeting clear the bar of expectations?
Head of FX Strategy
Summary: The market has ratcheted ECB tightening expectations up to new cycle highs just ahead of the ECB meeting today, making it difficult for Lagarde and company to exceed expectations on the hawkish side. EURCHF is at interesting resistance near 1.0500 ahead of the meeting, as peripheral EU spreads are also a focus on how the ECB signals what it will do about the risks of peripheral spread widening as it winds down balance sheet expansion ahead of the assumed July first rate hike.
FX Trading focus: Can ECB meeting clear the bar of expectations?
A few last thoughts on the ECB today: the key here is that expectations for this meeting are at the cycle peak and will require that the ECB delivers a lot to maintain the current pricing of the forward curve. Through the December ECB meeting, the market is pricing some 125 basis points of total tightening, meaning that, assuming there is no hike today (a real shocker if one is delivered), at least one of the four meetings after today and through the December meeting would have to be larger than 25 basis points.
The July meeting is trading at 50/50 odds for a 50 basis point move – this looks slightly aggressive, even if the ECB eventually gets to the +0.75% policy rate by year end. For example, Lagarde could repeat that the base case is for a 0% policy rate by end Q3 (after July and September meetings each see a 25-basis point hike), but could say that considering larger hikes beyond that could be appropriate if conditions dictate, etc.
Elsewhere, focus is on the staff projections – especially for inflation for 2023 and 2024, which were projected at 2.1% and 1.9%, respectively, in the March round of projections. A bump up to 2.0% for the inflation level for 2024 should be a given – anything higher would suggest a more hawkish lean. Also watch for exceptionally large downside GDP forecast revisions, which would indicate a “BoE-esque” concern for a stagflationary outlook and perhaps less willingness to hike aggressively beyond the first few hikes. The market is looking for modest downgrades for this year a next with a modest upward revision to the 2024 forecast (March projections for 2022-24 were +3.7%, +2.8% and +1.6%).
Finally, let’s see if the ECB spells out how it will address the “fragmentation” issue of peripheral sovereign yield spreads now that it is winding down its balance sheet expansion. Supposedly, a “new tool” is in the works for addressing this issue by shifting existing holdings to ensure even transmission of policy – but it will be important to track EU peripheral sovereign spreads in the wake of today’s meeting. 10-year Germany-Italy has settled near a spread of 200 basis points in recent weeks.
Bottom line – the ECB will have a hard time delivering a hawkish shock, which leaves the market to figure out what to do with an “as expected” outcome or something marginally dovish (strongly assuming we can rule out a dovish shocker). And don’t forget, the FOMC is up next week and we have a US treasury market that hasn’t chosen a direction of late.
EURCHF should prove one of the more reactive of the Euro pairs to the ECB meeting, both from a yield-spread perspective, depending on whether the ECB clears the bar of expectations as noted above, but also as the market will be watching EU peripheral debt markets closely as the ECB winds down its balance sheet. As well, the SNB has been rattling its cage on the need to tighten policy and has a long wait between its quarterly meetings – so the SNB meeting next week bears watching, as does the obviously important 1.0500 area on the EURCHF chart.
I brought up the importance of CNHJPY threatening the 20.00 level once again and now we have non other than Jim O’Neill, famed former Goldman Sachs Asset Management head, weighing in on the current JPY volatility, saying that “if you told me that yen [USDJPY] hits 150, this could be a rerun of the Asian Financial Crisis.” He suggests that further JPY weakening ratchets up the pressure on China “which might have the influence to force Japan to change its policy.” and that it was China that was partly responsible for bailing out Asia during the late 1990’s crisis by “signaling to the US Treasury to reverse its strong dollar policy or China would devalue its currency”. O’Neill says that he can’t see Japan sticking with the YCC policy, even if “it will be painful for financial markets [for the BoJ to end the policy], but it’s the right thing to do.”
Table: FX Board of G10 and CNH trend evolution and strength.
The JPY reading is getting extreme again with the latest move – interesting to watch the direction of yields over the next week after today’s ECB meeting and next week’s FOMC meeting. Elsewhere, the euro is getting something started, will the ECB cement this development today?
Table: FX Board Trend Scoreboard for individual pairs.
Watching USDCNH as a derivative of the CNHJPY and USDJPY situation and after the recent USDCNH new lows were rejected. USDCHF has also crossed back to positive and EURCHF is poised ahead of the 1.0500 area.
Upcoming Economic Calendar Highlights (all times GMT)
- 1100 – Mexico May CPI
- 1145 – ECB Rate Announcement
- 1230 – ECB President Lagarde Press Conference
- 1230 – US Weekly Initial Jobless Claims
- 1300 – Poland Central Bank Governor Glapinksi holds news conference
- 1400 – Canada Bank of Canada issues Financial System Review
- 1500 – Bank of Canada Governor Macklem press conference
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