We used the genie/bottle analogy, but you can pick your own.
SocGen’s Kit Juckes is going with Humpty Dumpty.
But whether you use genies and bottles, horses and barns, ships that have sailed, or fictional eggs having fallen off walls and broken, the point is simply that Mario Draghi cannot unsay what he said on Tuesday about looking through weak inflation on the way to rolling back (slowly) accommodation. And that means that the euro isn’t going to “un”-rally.
Perhaps the most important takeaway from what you’ll read below (excerpted from Juckes’ daily commentary), is the last paragraph.
Interest rate differentials are going to move against the dollar at the worst possible time (well, “worst” if you’re a dollar bull). The data is rolling over in the US and doubts persist about the viability of Trump’s growth-friendly agenda. As such, the greenback will likely remain on the back foot and as for equities, well, pray for buybacks…
Apparently, ECB President Mario Draghi’s comments about reflationary forces replacing deflationary ones were mis-interpreted by markets and were intended to be more balanced. A case of ham-fisted communication that argues for less forward guidance by policy-makers? Maybe, though I think the strategy on both sides of the Atlantic, which is to only change policy settings after ensuring markets won’t be surprised, has merit. And more importantly, will continue. What I don’t think, is that you can ‘unsay’ things by expressing surprise at the market reactions, any more than the king’s soldiers could put Humpty-Dumpty back together again.
The ECB isn’t going to hike rates soon. And how fast they move to reduce the pace of bond purchases probably does depend on how much the euro rallies. But the turn in the economy is pretty plain for us all to see. This week it has been the IFO survey and money supply data that show a continued acceleration in underlying loan growth. So of course the lifespan of extraordinarily easy policy settings (particularly asset purchases) is shortening. The lack of inflation, which is going to be highlighted today by Germany CPI figures that are likely to be as low as the Italian ones yesterday, ought to anchor bond yields and affect expectations about what removing extraordinary accommodation means, but they don’t change the fact that policy, like the economy, has reached a turn in the road. And that turn is positive for the euro, if only because it has been kept at a very low valuation by the combination of negative rates and bondbuying, despite a large current account surplus.
The ECB can’t normalise monetary policy without sacrificing the extreme cheapness of the currency, but maybe the ECB President thinks he can avoid a disorderly currency correction if he managers to guide market expectations. From here, we still think we’re a heading, erratically, towards EUR/USD 1.20 and above EUR/JPY 130.
Of course, it’s not just the ECB that is approaching a turn in the road for monetary policy. The Bank of Canada has prepared the market for higher rates to such a degree, in such a short time, that failure to hike next week would weaken the currency significantly unless there is a clear message that a hike is imminent. Data continues to point to economic improvement in New Zealand and Australia and ever-so-slowly the market is building up expectations on rates which underpin both currencies. And even in the UK, where we don’t expect a hike, the pound got further support from Mark Carney’s comments yesterday and could get more if the government softens its commitment on public sector pay restraint.
All of this means that the dollar gets less support from US interest rates. A stronger dollar needs higher yields now than it did before, because the rest of the world is moving. And what we have in the US is mixed economic data, a lack of inflation (it’ll be the PCE deflator we focus on tomorrow) and rising equity prices. More dividends and buy backs help keep the equity party going, which surely also help underpin Treasury yields, but won’t do that much for the dollar.