'Market should focus less on ECB, unless inflation weakens further' - Christopher Vecchio, DailyFX

Christopher
Vecchio

PROFILE:
• Current Job:  Currency Analyst for DailyFX.com in New York.
• Career: dual Bachelor of Arts degree in Government & Law and Economics from Lafayette College.

View profile at FXstreet.com

Christopher Vecchio is a currency analyst for DailyFX.com. With a background in political science and law, he focuses on the interrelationships between geopolitical events, macroeconomic trends, and market reactions. Also an active trader, Christopher monitors the markets around the clock.

When do you expect the impact of easing measures introduced by Mario Draghi at last week's monetary policy meeting to become fully visible? When and in what circumstances could the ECB take further action, hinted at by Draghi?

The efforts made by the ECB are established across all fronts, from traditional easing steps to non-standard measures. There were two definitive steps taken, however, that can be pointed to as perhaps viable reasons why the Euro didn’t endure a greater decline around the ECB’s meeting on Thursday. First, the ECB’s updated its expected EURUSD exchange rate over its forecast horizon to $1.3800 from $1.3600. Second, President Mario Draghi said in his Q&A that the ECB’s rates were essentially ‘at the lower bound’. What these slight tweaks to the ECB’s policies equate to is that, at current time, there is no real imperative to speculate that the ECB could cut rates further. Going forward, the market will pay less attention to the ECB – that is unless inflation data weakens to the point that further action may be necessary. Still, anything before the end of the stress tests (AQR, due at the end of October) seems unlikely as it would stir more confusion than anything else.

Will the mildly positive US jobs report for May push the FOMC to consider rising rates earlier than mid-2015? When could the first increase be carried out in your opinion?

The US Dollar’s position is a precarious one. While the yield environment has become somewhat more supportive, the data picture has not. The US yield curve has steepened slightly in the belly of the yield curve (3Y-7Y) over the past week and month, but it’s important to point out that the longer-term interest rates (10Y-30Y) are still rather suppressed. This is important because long-term interest rates are more sensitive to Fed rate changes than short-term interest rates; the market isn’t exactly pricing in a Fed rate hike anytime soon. The only slightly-positive yield environment backing the US Dollar is undercut by the weak economic growth environment currently persisting. While there have been tepid signs of a Q2 economic snapback (automobile sales, housing starts, jobless claims, and retail sales), the degree to which the data has rebounded is disappointing. Using the Citi Economic Surprise Index as a proxy for data momentum, the recent lull is apparent. The index reached a yearly low on April 7 at -45.9 then rebounded to 3.3 on May 20, but has since fallen back to -19.5 as of Friday.

Do you believe that the recent positive Japanese GDP numbers will convince the BoJ not to introduce further stimulus this year? Will PM Shinzo Abe be able to carry out another sales tax hike in 2014?

The economic situation in Japan has become more palatable for policymakers, and as a result, speculation over Japanese Yen weakness resulting from additional aggressive stimulus measures has been tempered. In recent weeks, Bank of Japan leadership has suggested that the uptick in inflation in the near-term reduces the need for further easing steps, a finding shared by the IMF in its recent 2014 Article IV Consultation on Japan.

Following recent ECB easing measures and amid widening spreads between the US and the Eurozone (Germany), do you see the EUR/USD nearer 1.3000 in the next months?

Not at present time. There is little indication that the Federal Reserve plans on hiking its main interest rates within the next year (next June at the earliest), and with the ECB having already played its hand, there are few viable catalysts that could spur such a depreciation at current time.

Do you think the GBP/USD could appreciate beyond 1.7000 before the year-end even when consensus point to the first BoE rate hike of the cycle in H1 2015? 

In what may prove to be an iteration of the timeless duel of the 'which is mightier - the pen or the sword?', the release of the May UK inflation report has done little to shake the market's faith in the Bank of England's fresh hawkish posture. Governor Carney couldn't have been more straight forward when he said that a rate increase "could happen sooner than markets currently expect." Whereas a Q2'15 rate hike was being priced in, swaps markets have repositioned themselves for an early-Q1'15 rate hike. A few more pieces of hot economic data, and it wouldn't be surprising to see those rate hike expectations spill over into Q4'14 - which would be a boon for the Sterling.