- ECB's tame speech suggests central bank toolkit is exhausted
- Transition to a fiscal focus is likely next step for policymakers
- EUR surged in its initial response but then reversed again
- Elsewhere, riskiest currencies came off hard, equities fell too
By John J Hardy
Yesterday's European Central Bank meeting disappointed on nearly all fronts, with no new easing measures announced despite a lower revision for inflation and growth. While president Draghi did mention that he has asked for an investigation into how the ECB can avoid running out of bonds to buy (one method could be by allowing a higher purchase percentage for individual issues), but the tone was very cool on the prospects for further easing and allocated a considerable percentage of his statement to the call for fiscal and structural reforms. This is another sign, on top of recent Fed rhetoric, that the limits of central bank’s current set of policy tools have been reached and we are seeing a transition to a fiscal focus.
The market reaction to the ECB was a bit mixed – first the euro surged on the lack of dovishness, but this was quickly reversed back to unchanged levels (for EURUSD, at least). Elsewhere, the fallout was more profound and meaningful, as the easy central bank and “reach for yield” themes have been the chief drivers of markets since the miserable start to the year yielded to a one-way surge in emerging markets and global equities. The riskiest currencies came off hard, equities drooped, and bonds sold off hard. This meeting could represent a profound shift away from the reach for yield and a retrenchment in bonds (higher yields) that will hit the higher yielders the hardest. In G10 land, this means AUD and CAD.
So on a deepening of the higher yield, central bank slowly taking away the punch bowl theme, we may see a stronger euro and a stronger US dollar. Elsewhere, the big question could be the Japanese yen. On the one hand, higher long yields in the US tend to mean a weaker yen, but if the Bank of Japan disappoints on September 21 by taking a similar course as the Fed and ECB by downshifting from signaling new easing, could the JPY be in for one last surge versus the broader market? We prefer USDJPY higher if yields are rising from here, with or without a shrug of the shoulders from BoJ chief Kuroda, but the path higher could be a rocky one.
The run higher in AUDUSD was turned yesterday as the lack of further easing signals from the ECB throws up a significant roadblock to the reach for yield theme. If risk appetite continues to crumble and yields head higher, the carry trade is likely to revers hard and take AUD and NZD significant lower, both here and versus the euro.
To the upside, on the other hand, if we are too hasty in our assumption, a close above 0.7700 would be a first for the cycle and likely mean a resolution higher as the carry trade re-engages.
The G-10 rundown
USD – Should be one of the chief beneficiaries if yields head higher and risk appetite softens on the lack of central bank accommodation signals – especially versus the commodity currencies, but also interested in implications for USDJPY and USDCHF if yields head higher.
EUR – may strengthen together with the USD if we are turning away from the reach for yield theme, particularly stronger against the commodity, risk-on currencies.
JPY – The September 21 BoJ policy meeting remains a critical question mark here, together with the interplay of bond yields, as higher yields tend to weaken the JPY.
GBP – a busy weak ahead with key UK data on the economic calendar. The Bank of England is not likely to announce anything new as the August easing announcement is likely to prove a one off. The focus will be on the switch to fiscal stimulus if UK data weakens. Would expect sterling to underperform USD and EUR if risk appetite drops.
CHF – EURCHF zipping back higher and we have maintained all along that the key driver for CHF will be the yield outlook – so if US rates pull notably higher, the USDCHF resistance could come back into view quickly and EURCHF could pull higher to the 1.1100/50 range.
AUD – together with NZD, the most impacted G10 currency if we are seeing a pivot away from the reach for yield theme. Bearish candlestick for AUDUSD yesterday – follow though below 0.7500 needed after recent missteps for bears, however.
CAD – employment data up today and interesting to note that CAD totally ignoring the latest spike higher in oil prices, preferring to focus on wilting risk appetite and the possible shift away from carry trades (where CAD was never really credible in the first place). USDCAD back above 1.3000 to close the week will get the bulls interested again.
NZD – the kiwi likely stands to lose the most if we are transitioning away from the reach for yield theme as carry trades go into hard reverse.
SEK – SEK was never a big beneficiary of the reach for yield, so EURSEK may remain rangebound and could punch lower if the recent bearish reversal after the 9.60 follows through.
NOK – the less accommodative ECB dominates the sharply higher oil prices yesterday, but EURNOK still looks heavy if we stay below the 9.25-ish area. Still, a shift lower in risk appetite not positive for NOK, so the implications are cloudy here.
Upcoming Economic Calendar Highlights (all times GMT)
- 0800 – Norway Aug. CPI
- 0830 – UK Jul. Visible Trade Balance
- 1230 – Canada Aug. Unemployment Rate
- 1230 – Canada Aug. Net Change in Employment
- 1330 – US Fed’s Kaplan to Speak
– Edited by Clare MacCarthy
John J Hardy is head of FX strategy at Saxo Bank