FxWirePro: ECB Preview Ahead of Global-Expansionary or Contractionary Monetary Policies

During ECB week and amid global slowdown, of course, talks about monetary policy patterns are quite common. One subject that made it back onto front-page news again this week: “over-indebtedness” amongst companies and households.

If institutions such as IIF and BIS are concerned about that, that is one thing. But if central bankers join the chorus (in the past this applied to for example BoE Governor Mark Carney or BoC Vice Governor Lynn Patterson) then we get hot under the collar. What do the central banks expect? Expansionary monetary policy always means that central banks convince/coerce commercial banks into extending their lending. What else would a central bank "ease" if not the conditions that determine lending? If they do so, the debt levels of all non-banks rise. All that means is that the global mega-expansionary monetary policy is not completely ineffective.

Of course, it is going to be painful if the central banks then decide to reverse that. But that is exactly the point of “restrictive” monetary policy. It is always painful in that sense and is intended to be. At that later stage, it all depends on the dosage if one wants to avoid a crisis. Of course, that is going to be difficult in view of the far-reaching unconventional tools that have been used. That is something that should have been considered when they were introduced. At the time, we got very cross about it, but today there is no reason for fresh anger.

Why that matters to the FX market? Because the antagonism of the global expansionary monetary policy is becoming increasingly clear: that first of all these tools are being used in an increasingly uncontrolled manner and that nobody believes any longer that this will make any difference, with the exception of the collateral damage the measures cause. What will be decisive for the development of exchange rates will be how the central banks treat this dilemma. If the ECB gets out the bazooka (20bp plus resumption of QE) - as our ECB watchers predict - it signals that it will continue, come what may. 

That will damage EUR exchange rates. If it was going to be more cautious it would recognize the antagonism. That would still not be an answer, but often an error confessed is half redressed. And it would be in clear contrast to the ECB’s previous approach when it brashly pretended that there was no dilemma. And this change of mind would be EUR positive, although unfortunately, the experts think it is unlikely to arise.

Hence, we advocated shorts in EURJPY futures contracts of mid-month tenors with a view to arresting potential dips. since further price dips are foreseen we would like to uphold the same strategy by rolling over these contracts for September month deliveries.

Crucially for EURUSD, the European data flow remains distinctly poor, Italy, for instance, is languishing in a self-inflicted recession, and the ECB is now acknowledging the persistence of these downside forces in a way that suggests it could temper its forward guidance on rates, potentially as soon as the March ECB meeting when the staff forecasts are next updated. So whereas it was understandable that EURUSD popped higher on the Fed, it is also understandable that the euro has been unable to sustain, let alone build on, those advances.

We maintain a neutral forecast for EURUSD over the coming quarter, and indeed continue to recommend tactical short option trades in EURUSD for the next month or two on the basis that: 1) poor European growth is likely to matter slightly more than a now-diffident Fed, and 2) the Fed may be on hold but the absolute level of USD interest rates remains supportive of short-term capital flows to USD. Courtesy: Commerzbank

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