ECB policy: Less dovish does not mean hawkish


Last week, Mario Draghi announced that the ECB would drop the commitment to increase its bond-buying programme should “the outlook become less favourable” – a pledge dating from December 2016 when the ECB first began to cut its bond-buying programme.   This pledge was widely considered to be the ECB’s signal to the markets that it had a dovish bias and so its removal last week was important, as in some ways it represents the first step towards European monetary policy normalization.

 

As such, you might have expected the euro to strengthen on this announcement – maybe even break through the stubborn 1.25 resistance level which has held back EURUSD in recent weeks.  And while the EUR did strengthen briefly, it quickly dropped over a cent, with EURUSD settling around the 1.23 level. 

 

There are a couple of explanations for the euro’s counterintuitive price action.  First of all, this is a classic “sell the news” event.  The euro has been rallying for over a year now, predicated on the belief that the ECB would begin to normalize monetary policy – now that Draghi has confirmed this, many investors will feel that it is time to get out of the trade.  This can be seen in the speculative positioning numbers, which show that hedge funds and other investors have cut their wagers on further euro strength by over 10% (albeit from record levels).

 

Secondly, Draghi also lowered his inflation expectations slightly – moving the 2019 inflation forecast to 1.4% (from 1.5% previously).  This might seem like a pretty minor revision, which nominally-speaking it is, but it is actually highly significant.  European inflation is well below the ECB’s 2% target, it is moving down rather than up (February’s inflation number was 1.2%, down from 1.3% in January and 1.4% in December), and the ECB has now confirmed that it does not expect any meaningful change for over a year.  This is in stark contrast to both the US and the UK, where inflation is now comfortably above 2% (too comfortably above in the case of the UK).

 

 

CHART: Euro Positioning

Source: Bloomberg

 

 

In other words, while the ECB has ditched its ‘dovish bias’, it is a long way away from following the Fed and embarking on interest rate hikes in the months ahead.  In fact, the probability of an ECB rate hike in 2018 declined by almost 25% following Draghi’s statement last week (and now sits just above 20%).  Throw a potential trade war with the US into the mix (and whatever the rights and wrongs of Donald Trump’s trade philosophy are, he is right that Europe relies on trade a lot more than America does), and we remain comfortable with our bearish call for EURUSD for 2018.  

 

 

Kevin Lester



 

White Papers

 

 

FX Hedging:

10 Common Pitfalls

Download> 

Commodity & FX Risk:

An Integrated Approach

Download> 

The Corporate Use of Credit Derivatives:

Where Next?

Download> 

Corporate Hedger’s Guide to Basel III

Download>

Currency Volatility – Are markets nearing an inflection point?

Download>

Testimonial

FX Risk

 

“Validus designed an innovative and practical hedging strategy to address our underlying FX risk in the context of very distinct and diverse sources of competition. We are delighted with the outcome and impressed with their on-going response to the changing business and market dynamics”.

 

Paul Stobbs, Managing Director, Attraction World

Testimonial

Private Equity

 

 “The Validus team understand how private equity thinks about financial risk management issues and they are rigorous in the way they help our portfolio companies to understand and mitigate their risks.”

 

James Markham, Partner – Portfolio Management, Graphite Capital LLP

Testimonial

FX and Commodity Risk

 

“Validus provides us with independent strategic advice relating to our long-term currency and commodity risk management program.  The people are extremely capable and collaborate very well with our finance and operations teams here at JD Irving.”

 

Mark Bettle, Director, J.D. Irving Ltd.

Testimonial

FX  Risk

 

 “Validus developed a tailored hedging solution to mitigate the risks from our unique combination of existing supplier agreements. The implementation and management of this rolling hedging programme with our FX service providers has been expertly and efficiently handled”.  

 

Mark Goldby, Finance Director, SMS Electronics Ltd.

Testimonial

Commodity Risk

 

“Validus worked with us to develop a comprehensive commodity risk management programme – their analysis was both insightful and actionable.   We particularly value their independence, and they continue to work alongside our internal team to ensure our commodity price risks are managed effectively”


Gerry Gray, Finance Director, Strix Ltd.


Testimonial

FX, Commodity & Interest Rate Risk

 

“Validus comes up with risk management solutions that are innovative and comprehensive but practical to implement, that is their strength compared to other consulting companies we have worked with in the past.  Validus provided valuable insights into how FX, interest rate and commodity risks impact our organisation, and provide actionable recommendations and solutions.”

 

Andrew Ayres, Finance Director, U-POL Ltd.

Recent Comments