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EUR: Volatile times ahead
The euro went on a roller coaster ride around the release of the statement and the press conference. Here are our three takeaways:
- First, this is another testament to how ECB hawkishness is proving insufficient to sustainably lift the euro. This is due to the fact that the deteriorating eurozone outlook and unstable risk sentiment continue to play a bigger role for the common currency. It also shows how markets had gone too far with their hawkish pricing before the meeting.
- Second, the sovereign spread factor is now officially the central theme in the eurozone. That is because announcing an anti-fragmentation tool and already laying out some relatively strict conditionality (the fiscal rule may be the main cause of concern) means that markets may stop focusing on the conditionality itself and instead look at the efficacy of the tool. This is especially true in the context of a collapsing ruling majority in Italy and a rise in the 10Y BTP-Bund spread caused by domestic political woes. The Lagarde-era ECB communication troubles may continue to be a source of downside risk to the euro, which will now trade more in line with sovereign spreads.
- Third, the end of forward guidance means that the market pricing on ECB tightening has lost an anchor and may make it (and by extension, the euro): a) volatile; b) more reactive to data; c) more reactive to ECB speakers. In other words, EUR volatility looks unlikely to fade this summer.
We’ll take a first look at the euro’s new reaction function to data releases today, as markets will focus on eurozone PMIs. Consensus expectations are for another drop, although quite contained in size (52.0 to 51.0 in the composite gauge, according to a Bloomberg survey). Anyway, some recovery in the dollar may keep EUR/USD below 1.0200 today.
An update about Italy: the President of the Republic will formalise the procedure for early elections over the coming days. The date for a vote has been decided: 25 September. Expect this to be mirrored in the EUR-crosses volatility curve. Opinion polls suggest the new prime minister could be Giorgia Meloni, leader of right-wing populist party Fratelli d’Italia, but she would need the support of another right-wing party (La Lega) and former PM Silvio Berlusconi’s party Forza Italia.
USD: Climbing back
A very eventful day in the eurozone resulted in high volatility but no real change in the overall G10 FX picture. The dollar is climbing across the board again this morning, and we are not surprised to see that.
We had previously highlighted how the narrative of other central banks closing the gap with the Federal Reserve did not seem to be a realistic driver of sustained dollar depreciation, and yesterday’s post-ECB moves were likely a case in point as they showed how: a) the diverging growth outlook and exposure to geopolitical risks remain a primary driver of FX; b) the pricing for some G10 central banks – but not for the Fed – is already very hawkish, limiting the scope for hawkish surprises to be passed through the domestic currency.
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Written by James Harte
With 10 years of experience as a private trader and professional market analyst under his belt, James has carved out an impressive industry reputation. Able to both dissect and explain the key fundamental developments in the market, he communicates their importance and relevance in a succinct and straight forward manner.
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Daily Market Outlook, July 22, 2022
Source: Tickmill
