FX Update: ECB surprises with 50-bp hike. Initial market reaction suggests a policy mistake. FX Update: ECB surprises with 50-bp hike. Initial market reaction suggests a policy mistake. FX Update: ECB surprises with 50-bp hike. Initial market reaction suggests a policy mistake.

FX Update: ECB surprises with 50-bp hike. Initial market reaction suggests a policy mistake.

Forex
John Hardy

Head of FX Strategy

Summary:  The ECB surprised many with the hike of fifty basis points that it pre-committed to at the prior meeting, choosing not to miss a beat in its pace of rate tightening despite the tremendous turmoil in global banks, and especially European banks this week. The initial market reaction was to sell the euro as bank stocks dropped further, suggesting that hot money reads this decision as a policy mistake, although the price turned choppy during ECB President Lagarde’s press conference.


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FX Trading focus: Euro initially weakens in wake of ECB sticking to its guns with larger hike.

The ECB surprised many by following through with the larger hike of 50 basis points, taking the deposit rate to 3.00%. The market was positioned for +28 basis points earlier today, i.e., some were looking for no hike, some looking for 25 bps and fewer expecting 50 bps. Easily as interesting as the decision itself was the reaction pattern across markets, which initially saw the euro lower, gold jumping higher and risk sentiment weakening, with banks under added pressure after the news that Credit Suisse would receive a lifeline from the Swiss National Bank this morning buoyed sentiment only briefly this morning. The German 2-year yield was virtually unchanged and near recent lows south of 2.50%. This suggests that the hot take is that the ECB may be making a policy mistake here in continuing to move forward with a large hike. Some of the reaction is already fading as the ECB President Lagarde press conference gets under way.

In support of its decision, the ECB argued that inflation is “projected to remain too high for too long” and offered no specific forward guidance on future rate moves, saying that the important of a “data-dependent approach”. The second paragraphs addresses “current market tensions” and touts the resilient Euro area banking system and the “fully equipped” ECB “policy toolkit” if any liquidity support or smooth transmission of monetary policy is needed. The new staff projections, the statement notes, were generated “before the recent emergence of financial market tensions” and “As such, these tensions imply additional uncertainty around the baseline assessment of inflation and growth.”

Chart: EURUSD
EURUSD came under some pressure after the ECB announcement as noted above, as the market’s hot take was that this was a policy mistake, though price action quickly turned choppy during the President Lagarde press conference (under way as of this writing). The coming week looks very important for markets through to the other side of the FOMC meeting next Wednesday (rate implications for the Fed not receiving much of an adjustment based on the ECB’s move today). EURUSD will trade in accordance with the direction in risk sentiment and in particular, bank stocks as we await a sense of whether the market can piece together stability or continues to fret the tectonic shift that has occurred, both from the US authorities’ move to bail out all depositors regardless of size (and what that means for bank oversight from here) and on the general awareness of the challenges banks face from the viciously steep rate tightening regime, with depositors possibly looking for safety and even income as they possibly shift into higher yielding money market funds and government treasuries. Rising funding costs for banks when their entire model is "borrow short and lend long" eventually spells credit contraction, and we are seeing some orange flashing lights in credit spreads, and red lights if simply considering the pace of widening, especially in Europe. Back to EURUSD: for today, watching the recent lows of 1.0516 for capitulation risk toward the 200-day moving average at 1.0325, while a significant sentiment shift and close back above 1.0700 to start is needed to suggest stabilization and renewed upside focus again.

Source: Saxo Group

Table: FX Board of G10 and CNH trend evolution and strength.
The NOK is getting the worst of the risk-off and weak crude oil prices. The euro’s up-trend has been almost entirely deflated, with the course from here dependent banks stabilizing.  The JPY continues to enjoy low bond yields, though very choppy post-ECB today.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.
EURUSD status over the next couple of daily closes as noted above, and similar for EURJPY, although the damage in the latter is far greater (but many horrific chops in the chart in recent months).

Source: Bloomberg and Saxo Group
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