Strategic Currency Briefing

Outlook:

The Draghi press conference today is probably going to be a disappointment. Analysts have already determined that the disappointing TLTRO issuance last month will be followed by another set of lackluster issues, and Europe doesn’t have enough securitized assets for the ECB to make a splash. Draghi is unlikely to speak of QE except to say it’s still on the table. The problem is not that the ECB is relatively powerless, but that Draghi is such an impressive and appealing figure that confidence in him alone will support the euro.

We are at risk of a spillover effect from dollar/yen to the whole FX market, which is overly long dollars in the first place. The dollar rally is a rare bird and there is no chart that doesn’t scream “correction needed.” One of the biggest problems in technical analysis is the assumption of “normalcy.” When we see breakouts followed by new breakouts, we expect pullbacks to “normal” levels by normal amounts. This is not to embrace any concept of central tendency but rather an observation on human behavior—when positions get extended, traders get jumpy and all too willing to jump off the bandwagon, setting off a cascade of reversals.

And yet the dollar rally has justifications, including relative growth, geopolitical worries driving safe-haven flows, impending energy self-sufficiency, and so on. Europe is in the soup and it’s possible China is, too. France’s Hollande said the equivalent of “mission accomplished” (the euro is now at a “more realistic” level) but Bini-Smaghi, in the FT today, points out that the euro has depreciated only about 4% against the dollar and 2% in “effective terms” since Sept 3. If expectations about strong ECB coun-termeasures are disappointed, “the depreciation of the euro could slow down, or even reverse. This would be quite damaging. In current circumstances the exchange rate is the most effective channel left for monetary policy to influence the real economy. Only a weaker euro can raise inflation to a level con-sistent with price stability and provide a short term stimulus to the eurozone.”

This is our view, too—only euro depreciation is going to work. The question is whether Draghi thinks so, and will say so in even the most roundabout way.