FX Update: Narrative around the ECB more important than the particulars

Forex 6 minutes to read

John Hardy

Head of FX Strategy

Summary:  While the ECB may be set to deliver new easing, we are concerned that the market has over-anticipated what this could mean for continuing to drive strong risk sentiment and asset prices. At the root of the issue is how long the market can maintain confidence in the effectiveness and quality of the central bank put from here. In that light, we’ll need to be cautious around the initial market reaction.


Trading interest

  • Staying long AUDNZD with stops below 1.0570 and targeting 1.0950

Risk appetite was boosted yesterday by both Chinese and American overtures on the trade front, as the former announced exemptions on tariffs for a number of product categories and the latter delayed the October 1 tariff raise to October 15 in respect of China’s National Day celebration. USDCNY traded down well below 7.10 into this morning and Asian markets and currencies in general celebrated this “breakthrough”, with the hope now that an October visit to Washington from Chinese . Trump’s firing of security adviser Bolton may be adding to risk sentiment at the margin as well on the hopes that he would prefer to default to avoiding geopolitical confrontation now for the duration to offer maximum support to the economy through next year’s US presidential election.

Today is ECB meeting day, with many items on the policy menu. First we are most likely to see an implementation of tiering of interest rates assessed on bank reserves akin to the Bank of Japan’s system in an effort to reduce the pain on EU banks affected by negative interest rates on their reserves (particularly an issue for German and French banks). Second, we will get a rate cut. Rate cuts are so futile I don’t understand why the ECB bothers, but that won’t stop them from delivering one. Given that Draghi is running out of time and will want to impress, a 20-bps cut might be a bit more likely than the market odds are pricing it at (about 40/60 for 20 vs. 10 bps).

The area where the ECB can surprise most is on the QE front, as renewed QE is clearly controversial on the ECB governing council and where estimates vary from EUR 20B to EUR 60B per month (consensus somewhere in the middle). Beyond these measures, however, it will be important to draw a signal during the press conference on whether Draghi gives the impression that the ECB is shooting its last bullets here or maintains the ability to continue to act. We think not – from here the power is in the hands of the EU and its political leadership as the central bank put has almost entirely lost its potency. In particular at today’s meeting, guidance that feels like Draghi improvising rather than expressing the view of the Governing Council will need to be taken with an extra grain of salt as this is his penultimate meeting.

Chart: AUDUSD
Yes, it is ECB day, but the key axis in the ECB reaction will likely be along the lines of risk appetite and whether the market can maintain the position that the central bank put remains effective and operational in the wake of whatever Draghi and company deliver today. So all of the risk/safe haven pairs, whether AUDUSD or NZDJPY or EURJPY could move in strong correlation once the market makes up its mind about the effect of new ECB easing beyond the headlines. On that note, a pair like AUDUSD is up against the wall, arguably needs to fade ahead of the 0.6927 retracement to maintain bear trend status that has been in place since early 2018.

Source: Saxo Bank

The G-10 rundown

USD – the greenback with its back up against the wall as risk appetite has staged a remarkable recovery and on the friendlier US-China overtures. Given where markets are trading, the Fed seems unlikely to deliver a particularly dovish message next week, and has to feel a bit rebellious after Trump labelled Fed leadership “boneheads” in a tweet.

EUR – If the market has overpriced ECB easing potential, would look for the Euro to back up sharply versus EM and risky currencies and trade sideways/lower versus the USD and the opposite on the ECB delivering big. Feels like the market is overconfident in what the ECB can deliver, but we’ll soon know.

JPY – yen getting further offers overnight on the strong risk sentiment and boost to bond yields on Trump’s overture to China. Key US yield benchmarks at important resistance (10-year at 1.75%) – next major level for USDJPY 109.00

GBP – UK Supreme court to now have a look at whether Johnson’s move to suspend parliament was unlawful after the Scottish high court said it was. We’re none the wiser on where this leads.

CHF – franc traders struggling to weigh ECB easing (euro negative) versus the rise in bond yields and strong risk appetite (CHF negative). An ECB under-delivery relative to expectations may see the latter a more important driver and EURCHF lower if the market throws a tantrum.

AUD – AUDUSD bears have their back against the wall here as a further charge higher through 0.6925-50 begins to  break the back of the bear market from early 2018.

CAD – CAD not participating in the risk-on as it has been resilient anyway all year and yesterday’s crude oil sell-off sounds a sour note.

NZD – kiwi enjoying the complacency and the Trump overture to delay the October tariffs – a bit more room to run to the upside without breaking things in NZDUSD and NZDJPY terms, but not much.

SEK – krona spiking back to the upside as externalities very supportive (especially risk sentiment) – the reversal looks impressive and if the ECB manages to exceed the dovish bar and boost risk sentiment across Europe, we could be looking at a technically decisive move through 10.60, opening the last bit of the range to 10.50

NOK – EURNOK working down to its key pivot zone, together with everything else risk-correlated, but with a bit of a drag from oil prices correcting on the fear that Trump’s firing of Bolton could mean a friendlier tone from the  US on Iran.

Upcoming Economic Calendar Highlights (all times GMT)

  • 0900 – Euro Zone Jul. Industrial Producttion
  • 1100 – Turkey Repo Rate announcement
  • 1145 – ECB Meeting
  • 1230 – ECB President Draghi Press Conference
  • 1230 – US Aug. CPI
  • 1230 – US Initial Weekly Jobless Claims
  • 1230 – Canada Jul. New Housing Price Index
  • 1700 – US 30-year Treasury Auction
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