The American exception
- USD still reigns over FX markets
- Markets anticipate ECB bond purchases
- GBP likely to align with USD, outpacing EUR
By Neil Staines
“US looks like an island of prosperity versus the rest of the world” - James Bullard
On Tuesday, we discussed the recent economic and monetary developments in the global economy and suggested that the USD was “the only game in (FX) town”. The events that have occurred since then have only added to our conviction.
Pictured: FX town (at least at the moment). Photo: Peshkova \ iStock
While the fireworks earlier this week were undoubtedly in the JPY, in the aftermath of the European Central Bank meeting it is likely that the USD’s ascent against the EUR becomes a more ingrained theme in forex trading.
“Overall, the euro area is grinding to a standstill and poses a major risk to world growth” — OECD chief economist Catherine Mann
In the run-up to this month’s ECB meeting, speculation had grown (in large part due to a Reuters report published on Tuesday) that there was growing disquiet within the governing council over the communication policy of Mario Draghi, particularly regarding his explicit reference to the ECB's balance sheet expansion.
His references at the two previous press conferences had implied a trillion-euro balance sheet expansion through covered bond and asset-backed securities purchases. If the disquiet were to be believed, then it potentially reduced the bank's commitment to large-scale expansion and thus (again potentially) stood to unwind some of the implicit easing bias of the ECB.
“Read my lips…” — George H. W. Bush
In a change to the opening paragraph, Mr. Draghi put paid to such speculation. He did this by maintaining the magnitude of the expected balance sheet expansion (back to 2012 levels) and by revealing that the formal description of the "expectation" contained in the statement had been agreed to by all governing council members.
In the post-meeting press conference (from which analysts and commentators expected no great surprises), Mr. Draghi’s rhetoric in relation to the ECB balance sheet expansion went a step further. Not only did he explicitly state that “ECB assets are to expand as others contract”, he also suggested that the ECB is ready to increase the stimulus if does not have the desired impact — even as covered bond and ABS purchases expand.
Furthermore, he stated that the bank is “unanimous in [its] commitment” to act again if growth or inflation expectations disappoint further. The governing council has also tasked staff with “preparing new measures to be implemented, if needed”, which likely means markets will increasingly anticipate purchases of corporate or even sovereign bonds (as well, perhaps, as some technical amends to the TLTRO programme), possibly as soon as December.
“Germany expects low ECB rates ‘somewhat’ beyond 2016” — Wolfgang Schaeuble
It is precisely this economic and monetary differentiation (that we have been proclaiming for some months now) that continues to favour the USD over both EUR and JPY.
Furthermore, as the US (and the UK) move further into the process of monetary normalisation, it is likely that this divergence continues (and widens) for some time to come. The USD remains the dominant force, but the economic and monetary characteristics and momentum of the UK should align GBP far closer to the USD than to the EUR or JPY.
In the UK, in contrast to the sharp downward revisions to growth prospects in the Eurozone (particularly Germany's recent correction), Britain's National Institute For Social and Economic Research (NIESR) raised its 2015 GDP growth forecast this week, to 2.5% from 2.3%.
It's no USD, but it's no euro either. Photo: Adam Gault \ Photodisc
Furthermore, we feel that the current market expectations regarding a UK interest rate hike have moved too far back. Consequently, we believe that economic momentum and interest rate expectations in the UK now offer a positive risk/reward trade-off for GBP in general.
Politics remain a slight drag for GBP at the current juncture, but at least against EUR (as well as AUD and JPY), the economic and relative value case for GBP outperformance remains compelling.
-- Edited by Michael McKenna
Neil Staines is head of trading at The ECU Group. Follow Neil or comment below to engage with TradingFloor.com's social trading challenge.