A Crushed Goldman FX Strategist Speaks: "We Badly Misread This Meeting"

Of all the mea culpas by the sellside penguin crew, the one post ECB mortem we were expecting above all, was that of Goldman FX strategist Robin Brooks who infamous, perhaps legendarily, opined just yesterday that "it remains the case that downside skew in EUR/$ is modest compared to the run-up to the Jan. 22 meeting. In short, we think risk-reward to short EUR/$ into tomorrow’s meeting remains compelling and we anticipate a 2-3 big figure drop on the day."

Well, Goldman was right about the 2-3 figure move... only it wasn't a drop. Actually make that 4-5 figure move in the wrong direction, in fact the biggest surge in the EUR since the announcement of the Fed's QE1!

So after waiting for a few hours, we were delighted to see that Robin is still ok, and sharing more muppet-crushing wisdom. Here is GOldman's just released note on the ECB's "shocker" titled "Dry powder, lost credibility." It is unclear just who lost credibility however.

From Goldman's Robin Brooks:

We badly misread this meeting.

 

Given the mixed messages from the ECB over QE, starting with the Bund sell-off in May, we had thought there were bigger stakes at play than the usual considerations around growth and inflation. Indeed, we expected President Draghi to deliver a forceful message, in part to fix some of the damage wrought over the summer. But today badly wrong-footed us and, in our view, further damaged the credibility of ECB QE.

 

As Exhibit 1 shows, the smaller-than-priced deposit cut was relatively minor in the scheme of things, moving EUR/$ higher by about one big figure (from 1.0550 to 1.0650), in line with our view that a 10 bps surprise maps into two big figures. The bigger disappointment came in the press conference, when a smaller-than-expected extension of QE, upward revisions to growth, and a stand-offish message on further deposit cuts took EUR/$ near 1.09.

 

Our impression from the press conference was that this message was deliberate, so that the Governing Council seems far less willing to ease aggressively than we had expected. At current levels, meaning around 1.09, EUR/$ prices only the 10 bps deposit cut, given that a good part of the decline from 1.13 prior to the Oct. 22 meeting was driven by the hawkish FOMC (Oct. 28) and strong payrolls (Nov. 6). That might be a reason to remain optimistic about further declines in EUR/$, especially with Fed lift-off around the corner. But the stakes for EUR/$ and the ECB are higher.

 

 

 

The big question today raises is whether the ECB is serious about QE. That question also arose over the summer, when the volatility in Bund yields raised questions over whether the ECB is willing to stabilize yields in Europe’s safe haven asset to encourage portfolio shifts into risk assets. Today’s sell-off in Bund yields (Exhibit 2) and the bounce in EUR/$ rivals those seen in April and May and again puts the question of ECB commitment to QE firmly on the table.

 

From an FX perspective, this matters a great deal, as today’s price action shows. The Euro rallied, driven by declining inflation break-evens and rising nominal yields, i.e., rising real yields. This price action has all the hallmarks of the Yen under Governor Shirakawa, as opposed to Governor Kuroda, raising for us the unpleasant possibility that the idiosyncratic Euro weaker story has been compromised. Even in the unlikely event that today’s disappointment was a mistake, we think it has cost enough credibility that the Euro down story we had envisaged is now less likely to play out. We are placing our forecasts under review.

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For those who skiped through all that here is the now traditional one picture summary: