Citigroup Explains How The ECB Will Drive The EUR Today

Citi's Steven Englander shares his outlook on what the key things to look out for, in the 8:30 am press conference, are. One variable in his forecast has already been presented: the cut was 25 bps not 50 bps. As he says: "By contrast, if they did 50bps and indicated that more aggressive measures might be forthcoming, the pendulum could swing to positive." In other words, the kneejerk jump in EURUSD following the ECB has been largely misguided for now, especially with forward EONIA rates jumping across the curve confirming that European liquidity is about to get far tigher all over again.

From Citigroup:

The ECB is the not the only game in town, but it is the first , so it is useful think about how its moves may affect the euro until the Summit results start emerging. Our economists write: “The ECB Governing Council is likely to cut rates today by at least 25bp to 1.0% (maybe even by 50bp to 0.75%) …. downward revision of the Eurosystem’s staff forecast for GDP growth in 2012 and the outlook for weak GDP growth and low inflation for 2013 …  probably will announce an extra LTRO with a maturity of at least 25 months and is likely to widen the collateral pool. ”

Importantly they add: “ we do not expect additional announcements from the ECB to support euro area sovereigns ...  [needing] further action from EU governments in order to see further action from the ECB.”

The two areas of uncertainty are 50bps vs 25bps and no additional bond activity versus some indication of more-to-come in terms of bond market intervention.
If the ECB does 25bps on rates plus the other expected measures, it is likely to come across as a bit disappointing to markets and EUR negative. Given that all political comments in the last two weeks have been aimed at getting the ECB more involved, the FX market would see it as a negative if they proved reticent. 

The most EUR positive outcome would be some commentary that is supportive of more engagement in bond markets, either by indicating that governments appear to be headed on the right track in fiscal terms or focusing on the degree to which the current rate structure represents unwarranted monetary tightness given the likely path of inflation and growth.  There is some debate over whether additional ECB engagement in sovereign bond markets would be a EUR plus or a negative. The argument for EUR-plus is that tail risk will fall, the EUR has been correlated with positive risk appetite for some years now and that convergence trades would attract capital in a euro zone without tail risk – I think this is the correct logic. The argument for EUR negative is that it would be viewed as a form of QE and put the ECB into the same category as the Fed and BoE in the eyes of investors.

The most uncertainty is what if they do 50bps, but give no nod to bond buying. This may be close to neutral, with the demonstration that they are willing to be aggressive on conventional monetary policy offsetting the disappointment on the long end. If they shut down the possibility of additional engagement in the sovereign bond market, the outcome would swing to EUR negative. Most FX investors see the problems of the euro zone as focused  on risk premia rather than the base level of rates, so adamantly sticking to central bank knitting would disappoint. By contrast, if they did 50bps and indicated that more aggressive measures might be forthcoming, the pendulum could swing to positive.

The EUR move could be quite large if the ECB was seen as laying down a marker one way or another. Most likely the reaction will be muted by the knowledge that there will be leaks galore out of the Summit the next two days, and investors will want to assess the net of fiscal and monetary policy outcomes, rather than a single leg. 

Out of these possibilities, I see a little more room for disappointment than for a positive EUR surprise, since the ECB emphasis could be on the conventional rather than non-conventional side.


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