Ok, so just a quick note on the euro.
After blowing through 1.20 on Tuesday and getting some notable traction as a safe haven, the single currency has come off a bit on Wednesday, providing some welcome relief to eurozone equities which hit 6-month lows yesterday.
The relief rally in the dollar now has the euro on pace for its first two-day decline in nearly two weeks. As Bloomberg noted earlier this morning, “longs were stopped out and interest to fade the dip lies lower than current levels.”
But this (likely fleeting) bit of respite notwithstanding, the consensus seems to be that Mario Draghi is going to have to do something to put a stop to this.
Because assuming the German elections go as planned, and assuming Donald Trump stays crazy (both of which seem like good bets), there’s every reason to believe the backdrop will remain euro supportive – especially when you consider that Janet Yellen will be hamstrung in terms of how aggressive she can get by fiscal gridlock.
Well for their part, Deutsche Bank thinks Draghi is largely powerless.
“The ECB meeting is coming up next week and there are rising risks of verbal intervention from Mario Draghi,” the bank’s George Saravelos writes, in a note dated Wednesday, before adding that “ECB verbal rhetoric may cause a correction but is unlikely to be enough to derail euro strength.”
On valuation, Deutsche notes that “EUR/USD is only just now approaching ‘fair value’ on a number of metrics”:
Our estimate of purchasing power parity (PPP) for the euro is 1.23 (chart 2). Our fundamental effective exchange rate (FEER) model which adjusts for the euro’s large current account surplus is 3% higher. The BEER model which adjusts PPP for productivity and terms of trade is a little lower. The same conclusions apply to the trade-weighted index, there is nothing unusual about the euro’s current valuations.
After noting that speculative positioning is not as extreme as it looks if you account for rising trading volumes and adjust for open interest, ol’ George then comes to the main takeaway:
Verbal intervention may not be a game changer. First, everyone is now expecting it. Second, for verbal intervention to be credible the ECB will need to abort its QE exit plans for October.
That bolded bit is not likely for all kinds of reasons including the message it would send about the ECB’s outlook for inflation and the economy, but technically speaking, Deutsche notes the following:
The current level of the euro would only require a 0.2% upward revision to European growth over the forecast horizon to maintain the ECB’s inflation path. It is only at 1.25 or above where tapering would be aborted (chart 7).
Monetary policy is simply not the main driver of EUR appreciation. The market is becoming more structurally optimistic on Europe versus the US and the ECB may not be able to do much about it.
So the message for Draghi – and implicitly for anyone who is betting on the DAX to rebound – is this: tough shit.
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