ECB: Let the euro bears eat cake - SocGen

The ECB is set to have its cake in the form of a slower pace of bond-buying, and eat it with a satisfying side dish of euro softness, explains the research team at Societe Generale.

Key Quotes

“The euro is vulnerable now that the highly-anticipated ECB QE tapering announcement is behind us. Indigestion comes later, when the long-term uptrend resumes, as the euro’s cheap valuation and the steady improvement in the underlying pace of growth suggest it will before all that long.”

“So far, so good. After prepping the markets with leaks in the preceding weeks then giving them exactly what they were expecting, the ECB has succeeded in announcing a slower pace of bond-buying, while sending the euro lower, while European equities rallied. Bond yields have fallen and the spreads between peripheral markets and Bunds have narrowed significantly as a wave of relief flows through the market that the ECB’s supportive hand won’t be removed more quickly. A EUR 30bn/month pace of bond-buying was exactly as expected and comments about avoiding a sudden stop in buying keep the door open to a few more months of purchases after next September.”

“Given the erosion of yield support for the euro in recent weeks, it is vulnerable now that the anticipated ECB QE tapering is a done deal. ECB President Mario Draghi noted in his comments that core inflation had yet to show a convincing upward trend. The market’s focus from here will be on whether inflation pressures in the euro area do indeed rise, as that would open the door for a more hawkish ECB. It is also interesting to note that despite the sideways price action in the euro for almost three months, CFTC data do not indicate any sizeable drop in the elevated speculative net long positioning on the single currency. We debate the significance of this positioning data without reaching a clear conclusion, but as EUR/USD breaks key supports and yield differentials move against it, the potential for speculative longs to be flushed out is obvious.”

“If all the pieces are in place for a deeper euro correction however, the longer-term fundamental case for a stronger euro also bears reiterating Economic growth momentum in the euro area is strong, and we see upside risks to growth next year. The disconnect between current real Bund yields and the strength of the euro area economy will act as a magnet dragging the euro higher in due course. Moreover, the euro remains undervalued according to long-term valuation metrics, and the region enjoys a persistent current account surplus.”

“As such, we retain our bullish medium-term view on EUR/USD, and expect new cycle highs in 2018. The OECD PPP is at 1.33, the Big Mac index at 1.25. The ECB may have played its tapering card very well, but a runaway IFO, a big current account surplus and a significantly undervalued currency don’t sit well together. The only treason we’re here is that we’ve come back too fast from the even lower levels of early 2017.”

“Our technical analysts are highlighting intermediate support layered at 1.1660/18, and below that 1.1460 as key support of the longer-term uptrend. We’re looking for a move to 1.15 to get long euro and euro-related currencies against the dollar bloc. EUR/JPY may be a buy even sooner as USD/JPY will be supported by the rise in US yields and by the continuation of BOJ policies in the face of soft inflation. We’re unlikely to see a return to EUR/JPY 130 but we do expect a move towards 14 over time.”