Buy EUR/USD this week - Morgan Stanley
EUR: Trading The ECB: 'Pride & Prejudice' - BofA Merrill Going back to the drawing board immediately after having delivered another layer of accommodation - even if it was received as insufficient by the market - is not going to be an appealing option for the ECB. True, one could return Draghi's comments straight to him: if a central bank's credibility must be judged by its capacity to deliver on its mandate, here price stability, and not on its willingness to stick to a particular stance or instrument - the point he used to justify the U-turn on the deposit rate - then there is no reason why the Governing Council should request a "decency delay" before acting again if the situation requires it. Still, institutions have their pride, and we suspect that a prejudice to see the December package as sufficient for some time will inform the Governing Council's approach to the news-flow.
Actually, to be fair the ECB is faced with a complicated configuration: inflation is clearly not on its preferred trajectory, and equity markets are markedly down (which should normally matter more than usual since higher equity prices are one of the transmission channels of QE), but the data flow on the real side of the economy is actually more than decent in the Euro area. This we think will allow a majority of Governing Council to continue to argue that the current stimulus is gradually working its way through the economy and that, ignoring the transient effects of lower oil prices, this should ultimately lift core inflation to a pace consistent - at a rhetorical stretch - with a return to price stability in the medium term.
We think that this is too optimistic, not necessarily because the Euro area's economy is going to relapse, but because even reduced slack won't trigger the kind of rebound in endogenous inflation the ECB is pinning its hopes on. Still, in light of the prudent approach in December, we do not think the ECB is ready yet to review its arsenal and get a more realistic view of the power of its weapons.
(Not so) Great Expectations: While we agree that the ECB can quite easily wait in Q1, we continue to think that the Governing Council will ultimately be forced into another layer of accommodation by the end of the spring. In our view, the central bank will not be able – in a context of continued misses from trajectory on actual consumer prices – to continue to ignore the marked deterioration in inflation expectations. 5Y5Y breakevens did not recover from the disappointment of 3 December. This suggests that the positive correlation between oil prices and long term inflation expectations has reappeared, while the expectation of more forceful ECB action in December of last year had made this disappear. This is a direct threat to the central bank’s credibility. If the market dislocation continues at the same pace as it has over the last two weeks, or if real economy data starts plunging, then the March meeting is “live”.
We think though that this is a bit too early to get the central bank in activist mood again. True, by then the Governing Council will have a complex moment, dealing with yet another downward revised batch of forecasts, but in March the projection horizon will extend to 2018. This could give the ECB more room for manoeuvre, claiming that after some delay price stability would be achieved again. Obviously, further misses into the spring would make a rosy 2018 forecast increasingly shaky, but the ECB could always correct that in June. In light of what we think is a limited scope for more action on the depo rate, additional action in the spring would have to focus on QE.
EUR/USD: 'Constant Buffeting': A Trade Idea - NAB Investor nervousness and risk-averse sentiment was clearly very present at stages through Q4 last year, causing the Fed to hold off a rate move in October and both the ECB and BoE to adjust their own views and policy stances during that quarter. The Fed though had surely hoped its decision to hike on 17 December would be seen as a ‘cheerleading’ move and one that could instil investor confidence that the US economy was on the road to recovery. A bias to ease by the ECB and PBoC among others, combined with some stability in oil prices for most of December and the expectation of monetary policy divergence, held open the possibility of a more optimistic start to 2016 with only a gradual grind higher in the USD. Anticipated capital outflows from EM would usher in modest EMFX weakness – at least that was the plan.
The PBoC is blowing hot and cold in how it deals with CNY sales. December saw unexpectedly large intervention above $100bn. Early January saw the PBoC apparently holding back, allowing CNY and CNH weakness before hitting CNH sellers hard with penal short-term carry costs. That seems to have halted the CNY slide for now, but global markets remain on edge. We’d note as in August, investor unease seems more related to policy shifts and often obscure communication, much of which seems on the hoof. Official Chinese data has actually been improving since November. Q4 GDP, industrial production, retail sales and FAI due this week will be a driver. If GDP prints +6.9% y/y , with the tertiary (service sector) growing above the secondary (manufacturing sector) again we may well see things calm here for now and as long as Beijing attempts to keep the CNY gyrations under wrap.
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EUR/USD to rise on less dovish ECB
Currency investors should consider buying EUR/USD this week, advises Morgan Stanley in its weekly FX pick to clients. The following is MS' rationale behind this call along with the details of the entry, stop, and target for this tactical long EUR/USD trade.
"With the BoJ showing increasing signs of nervousness, investors are looking for an alternative asset currency. Bullish EURUSD positions should perform well should risk appetite remain offered, in our view. We are concerned that the next leg lower in equity markets could be driven by US data weakness.
Friday's comments by Fed's Dudley, which were less dovish than hoped, have made clear that the Fed is not willing to change its reaction function in light of weak data and market revolt, yet. After hiking rates in December, the Fed may have entered a position of high vulnerability. Markets have only priced in one additional hike for this year, but in order to 'get back ahead of the curve', the Fed would have to signal that it may hike rates all this year. Dudley's comments suggest that the Fed is not yet ready going into this direction. With the Fed on the sideline and strong earnings releases beating expectations unable to stabilise the equity market, all eyes will be on global data releases, which we expect to stay weak.
The EUR benefits from safe-haven flows unless the ECB does reduce its deposit rate further. However, the outcome of the December meeting and recent ECB communication suggest that a further deposit cut is a less preferred policy tool compared to QE. The problem is that additional QE may not impact the yield curve sufficiently to weaken the EUR," MS says as a rationale behind this call.
In line with this view, Morgan Stanley recommends buying EUR/USD at market (currently at 1.0894) with a target of 1.1300 and stop at 1.0850.
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