Riding the Fed-ECB Policy Divergence Riding the Fed-ECB Policy Divergence Riding the Fed-ECB Policy Divergence

Riding the Fed-ECB Policy Divergence

Macro 3 minutes to read
Charu Chanana

Head of FX Strategy

Summary:  US inflation report this week resulted in markets re-assessing whether the three Fed rate cuts could still come this year. On the contrary, the European Central Bank indicated that it could cut rates in June. This widening Fed-ECB divergence could bring scope of outperformance of European equities and bonds over their US peers, while EURUSD could see a medium-term downtrend. Scope of correction in EURNOK and EURCHF also seen.


What happened this week?

  • US CPI for March came in hot yet again. This was the third consecutive print of higher-than-expected inflation, questioning why the Federal Reserve needs to cut rates. Markets now price in the first full Fed rate cut only in September and less than two full rate cuts for 2024 from the Fed.
  • Meanwhile, the European Central Bank left policy rates unchanged at its April meeting, but the Governing Council’s updated policy statement clearly indicated an intent to start cutting rates at its next meeting in June, even as data-dependency was a key message.

     

    What does this mean?

  • The economic resilience, sticky inflation and a pushback from Fed speakers are making a case for the Fed to lag the next easing cycle. Green shoots in Europe and China are signalling an upturn in the manufacturing cycle, shelter inflation (a large component in US CPI) remains sticky, and the labor market still remains tight.
  • Euro-area inflation slowed more-than-expected in March with CPI at 2.4% YoY from 2.6% in February. This adds to the case that inflation could return to the 2% target in Q2 and supports the case for the ECB to start cutting rates in June.
  • Services inflation is still a risk for the ECB, which could mean that the ECB may remain cautious about the pace of easing cycle after June. Any weakness in EUR could also mean imported price pressures, especially if commodity prices remain high.
  • However, if the Fed starts to cut rates as well, there could be room for the ECB to remain more aggressive in the current easing cycle.

     

    Investment implications

  • European equities could outperform US peers: The upturn in manufacturing cycle and signs of bottoming out in China have already helped European stocks to outperform the US equities YTD. EuroStoxx 50 is up ~10% YTD as against gains of 9% in S&P 500. Valuation discount and diversification away from technology also make European equities a great choice for investors. The ECB rate cuts from June could potentially bring the next leg of outperformance in European equities. Read more on the investment case for European equities from our Head of Equity Strategy, Peter Garnry, in this article.  
Source: Bloomberg
    • Outperformance of European sovereigns over US: An early start of the rate cut cycle by the ECB compared to the Fed could boost the European sovereign bonds over the US Treasuries. The gap between the benchmark 10-year German and US borrowing costs has widened to over 200bps, its highest levels since November. Further evidence in the data to suggest that the ECB could continue to be more aggressive in its easing cycle compared to the Fed can further widen this spread. Current high yields provide an attractive carry and potential for ECB rate cuts boosts the potential for capital gains from European sovereigns. Read more on the investment case for European sovereigns from our Head of Fixed Income Strategy, Althea Spinozzi, in this article
Source: Bloomberg
  • EURUSD is threatening to break below YTD lows: EURUSD tested the February low of 1.0695 following the ECB announcement on April 11. Fed-ECB divergence spells further downside for EUR and our technical strategist is expecting a bearish breakout and next key level at 1.0660 followed by 1.0596. On the crosses, EURNOK could be pressured lower with NOK being supported by higher crude oil prices and a higher wage growth negotiated in Norway which could signal a delay in rate cuts from Norges Bank. EURCHF could also reverse the gains seen since the start of February as geopolitical risks remain on the radar.

     

  • Slowdown in commodity rally: The recent momentum in commodities could be at risk of a correction if the dollar strengthens on the back of weakness in EUR. Note that EUR has the highest and over 50% weight in the Dollar (DXY) index which makes dollar vulnerable to the moves in EUR.

-----------------------------------------------------------------------

Other recent Macro/FX articles:

12 Apr: Global Market Quick Take - Asia
11 Apr: ECB rate decision: How to trade the event
9 Apr: CAD vulnerable as market underprices dovish Bank of Canada risks
9 Apr: US inflation report: How to trade the event
8 Apr: Macro and FX Podcast: NFP, CPI, ECB and Japan
8 Apr: Weekly FX Chartbook: US CPI, geopolitics and dovish pivots from ECB and Bank of Canada in focus
3 Apr: Chinese yuan bears are undeterred by PBoC’s grip
25 Mar: Macro & FX Podcast: Swiss central bank surprises; PCE and China
25 Mar: Weekly FX Chartbook: The return of US exceptionalism
22 Mar: Swiss National Bank’s bold move will kickstart the G10 rate cut cycle
20 Mar: Thematic Podcast: Japan's route to abolish negative interest rates
20 Mar: Japan’s exit from negative rates: Implications for the economy, yen and stocks
19 Mar: FOMC rate decision: How to trade the event
18 Mar: Macro & FX Podcast: Central bank meetings all over
18 Mar: Weekly FX Chartbook: Heavy central bank focus as FOMC, BOJ, BOE, SNB, RBA meet
14 Mar: FOMC vs. BOJ: Who moves the Yen?
12 Mar: Dampening equity sentiment could test GBP resilience
11 Mar: US inflation report: How to trade the event
6 Mar: Bitcoin fever is running high, again
5 Mar: FX & Macro Podcast: US jobs data, China's "Two Sessions" & Super Tuesday
28 Feb: Navigating Japanese equities: Strategies for hedging JPY exposure
23 Feb: Nvidia momentum spills over to FX markets
21 Feb: Central bank divergence on the radar: Hawkish RBNZ, Dovish BOC and SNB
15 Feb: Swiss Franc’s bearish view gets more legs
14 Feb: Sticky US inflation could make dollar strength more durable
9 Feb: Japanese Yen is throwing a warning
8 Feb: FX 101: USD Smile and portfolio impacts from King Dollar

Disclaimer

The Saxo Group entities each provide execution-only service and access to Analysis permitting a person to view and/or use content available on or via the website is not intended to and does not change or expand on this. Such access and use are at all times subject to (i) The Terms of Use; (ii) Full Disclaimer; (iii) The Risk Warning; (iv) the Rules of Engagement and (v) Notices applying to Saxo News & Research and/or its content in addition (where relevant) to the terms governing the use of hyperlinks on the website of a member of the Saxo Group by which access to Saxo News & Research is gained. Such content is therefore provided as no more than information. In particular no advice is intended to be provided or to be relied on as provided nor endorsed by any Saxo Group entity; nor is it to be construed as solicitation or an incentive provided to subscribe for or sell or purchase any financial instrument. All trading or investments you make must be pursuant to your own unprompted and informed self-directed decision. As such no Saxo Group entity will have or be liable for any losses that you may sustain as a result of any investment decision made in reliance on information which is available on Saxo News & Research or as a result of the use of the Saxo News & Research. Orders given and trades effected are deemed intended to be given or effected for the account of the customer with the Saxo Group entity operating in the jurisdiction in which the customer resides and/or with whom the customer opened and maintains his/her trading account. Saxo News & Research does not contain (and should not be construed as containing) financial, investment, tax or trading advice or advice of any sort offered, recommended or endorsed by Saxo Group and should not be construed as a record of our trading prices, or as an offer, incentive or solicitation for the subscription, sale or purchase in any financial instrument. To the extent that any content is construed as investment research, you must note and accept that the content was not intended to and has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such, would be considered as a marketing communication under relevant laws.

Please read our disclaimers:
- Notification on Non-Independent Investment Research (https://www.home.saxo/legal/niird/notification)
- Full disclaimer (https://www.home.saxo/en-hk/legal/disclaimer/saxo-disclaimer)

None of the information contained here constitutes an offer to purchase or sell a financial instrument, or to make any investments. Saxo does not take into account your personal investment objectives or financial situation and makes no representation and assumes no liability as to the accuracy or completeness of the information nor for any loss arising from any investment made in reliance of this presentation. Any opinions made are subject to change and may be personal to the author. These may not necessarily reflect the opinion of Saxo or its affiliates.

Saxo Capital Markets HK Limited
19th Floor
Shanghai Commercial Bank Tower
12 Queen’s Road Central
Hong Kong

Contact Saxo

Select region

Hong Kong S.A.R
Hong Kong S.A.R

Saxo Capital Markets HK Limited (“Saxo”) is a company authorised and regulated by the Securities and Futures Commission of Hong Kong. Saxo holds a Type 1 Regulated Activity (Dealing in Securities); Type 2 Regulated Activity (Dealing in Futures Contract); Type 3 Regulated Activity (Leveraged Foreign Exchange Trading); Type 4 Regulated Activity (Advising on Securities) and Type 9 Regulated Activity (Asset Management) licenses (CE No. AVD061). Registered address: 19th Floor, Shanghai Commercial Bank Tower, 12 Queen’s Road Central, Hong Kong.

Trading in financial instruments carries various risks, and is not suitable for all investors. Please seek expert advice, and always ensure that you fully understand these risks before trading. Trading in leveraged products may result in your losses exceeding your initial deposits. Saxo does not provide financial advice, any information available on this website is ‘general’ in nature and for informational purposes only. Saxo does not take into account an individual’s needs, objectives or financial situation. Please click here to view the relevant risk disclosure statements.

The Saxo trading platform has received numerous awards and recognition. For details of these awards and information on awards visit www.home.saxo/en-hk/about-us/awards.

The information or the products and services referred to on this site may be accessed worldwide, however is only intended for distribution to and use by recipients located in countries where such use does not constitute a violation of applicable legislation or regulations. Products and services offered on this website are not directed at, or intended for distribution to or use by, any person or entity residing in the United States and Japan. Please click here to view our full disclaimer.

Apple, iPad and iPhone are trademarks of Apple Inc., registered in the US and other countries. AppStore is a service mark of Apple Inc. Android is a trademark of Google Inc.