The Euro May Launch Higher if the ECB Holds Back Dovish Posturing
The Euro May Launch Higher if the ECB Holds Back Dovish Posturing
By:Ilya Spivak
The currency has been grinding upward since posting a two-year low just above 1.03 against the U.S. dollar
- The euro is up from two-year lows, thanks to a retreating U.S. dollar.
- Macro headwinds battering the Eurozone are becoming stronger.
- If the ECB withholds more dovish guidance, the euro may push up.
For all the headwinds battering the euro recently, it has been remarkably resilient against the U.S. dollar. The currency has been grinding higher since posting a two-year low just above 1.03 against the U.S. dollar in late November. That put the brakes on a blistering down move of nearly 8% from highs above 1.12 in late September.
The sell-off developed in line with a broader dollar rally following the start of interest rate cuts by the Federal Reserve. The markets judged that the central bank’s dovish posture coupled with brisk U.S. economic growth would revive inflation pressure. This fueled a downshift in the rate cut outlook for next year, lifting Treasury yields and the greenback.
The Eurozone is facing mounting macro headwinds
The same dynamics have delivered the euro rebound in the past two weeks. The U.S. “reflation trade” seemingly ran out of steam after the Federal Reserve’s November policy meeting as near-term policy expectations calcified, giving the markets room for the unwinding of speculative exposure.
Meanwhile, the local story in the Eurozone has seemingly gone from bad to worse. First, the economy has slipped back into recession-like conditions. November purchasing managers index (PMI) data from S&P Global showed growth of economic activity contracted at the fastest pace since January. A modest pickup earlier in the year has lost steam.
Credit stress has also returned. The collapse of the fragile minority government in France has sent its bond yields soaring. The markets are worried that embattled President Emmanuel Macron will struggle to pass a budget. The spread between French and German 10-year rates is at its widest since mid-2012, amid the Eurozone debt crisis.
The euro may rise if the ECB withholds dovish guidance
Inflation expectations are annoyingly marching higher even as the economy hits the skids and electricity prices move up ahead of peak winter usage. One-year forward French and German baseload power prices have been rising on the European Energy Exchange (EEX) since mid-September.
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All this makes for a thorny backdrop as the European Central Bank (ECB) convenes a policy meeting this week. The central bank is widely expected to cut its target deposit interest rate by another 25bps to 3%. The priced-in probability of the move stands at close to 76%, based on benchmark ESTR rate futures.
That is likely to shift traders’ focus on the guidance about what is likely ahead in 2025. As it stands, the markets anticipate a further 115bps in cuts next year. If the many crosscurrents facing the central bank distill down to indecision and it opts for a neutral “wait-and-see” message to the markets, the euro may rally with relief.
Ilya Spivak, tastylive head of global macro, has 15 years of experience in trading strategy, and he specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak
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