EUR
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
Hawkish! This sums up the Feb ECB policy meeting. The initial statement was in line with Dec guidance and offered very little surprises (which was initially seen as dovish). However, during the press conference President Lagarde explained that the upside surprises in CPI in Dec and Jan saw unanimous concern around the GC in the near-term and surprised markets by not repeating Dec language which said a 2022 rate hike was unlikely (which immediately saw STIR markets price in a 10bsp hike as soon as June). The president also made the March meeting live, by stating that they’ll use the March meeting to decide what the APP will look like for the rest of 2022 (which markets took as a signal that the APP could conclude somewhere in 2H22. After the meeting we had the customary sources comments which stated that the ECB is preparing for a potential policy recalibration in March (with some members wanting to change policy at today’s meeting already) and added that it is sensible not to exclude a 2022 hike as a possibility and also stated that the ECB is considering possibly ending the APP at the end of Q3 (which would put a Q4 hike in play). Furthermore, sources stated that if inflation does not ease, they’ll consider adjusting policy in March (which means incoming inflation data will be critical). The shift is stance and tone were significant for us to change the bank’s overall policy stance to neutral and to adjust the EUR’s fundamental bias from dovish to neutral as well. Incoming inflation data will be key from here.
2. Economic & Health Developments
Even though the recent activity data suggests the hit to the economy from previous lockdowns weren’t as bad as feared, the additional lockdown measures across Europe has weighed on incoming data. Growth differentials still favour places like the US and UK above that of the EZ and alongside the clear monetary policy divergence means the bearish bias is firmly in place. On the fiscal front, attention is on ongoing discussions to potentially allow purchases of ‘green bonds’ NOT to count against budget deficits. If approved, this could drastically change the fiscal landscape for the EZ and would be seen as a big positive for the EUR and EU equities.
3. Funding Characteristics
As a low yielder (like JPY & CHF), the EUR has been a funding choice among carry trades, especially during 2019 where it was a favourite against high yielding EM. As such, part of the EUR’s upside after the initial risk-off scare in March 2020 was attributed to a major unwind of large carry trades. As more central banks start normalizing policy and rate differentials widen, the EUR’s use as a funding currency could add additional pressure in the med-term , but keep in mind it could also spark risk off upside if some of those trades unwind.
4. CFTC Analysis
Remember that the ECB meeting this past week took place on Thursday, that means that the most recent CFTC update will not include the big jolt higher in the EUR across the board. We would expect next week’s data to show a sizeable increase in large spec net-longs as well as a very big reduction in leveraged fund net-shorts. With so many negatives priced in for the EUR in recent weeks, the unwind could be punchy.
5. The Week Ahead
In the week ahead we have a very light economic calendar coming up for the Eurozone, but we do have quite a few ECB speakers lined up and that will take centre stage for markets. Looking at the moves in both bund yields and the EUR, the ECB members will no doubt have quite a few questions they’ll need to answer and will want to give their own views and opinions. If the ECB thinks the markets overreacted to the message conveyed by President Lagarde, they will want to use this week to get on the wires as much as possible to correct any misplaced expectations. That means President Lagarde’s testimony before the EU Parliament Economic and Monetary Affairs Committee will be scrutinized for any additional details and info, especially with markets now pricing in over 50 basis points of tightening by year-end as well as a Q2 end to QE . Without any strong push back from the ECB in the week ahead will likely lead to a further unwind in short-positioning and should continue to be supportive for the EUR in the very short-term.
GBP
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
Hawkish surprise with a hint of dovish undertones sums up the Feb BoE decision. The bank announced the start of passive QT and also hiked rates by 25bsp as expected, but the vote split was unanimous (9-0) but with a big hawkish surprise being 4 MPC members voting for a 50bsp hike. Inflation forecasts saw a big upward revision to a 7.25% peak by April ( prev . 6.0%) & 5.21% in 1-year ( prev . 3.40%). This initial hawkish statement saw immediate strength for GBP but during the press conference the BoE tried their best to get a dovish landing. Gov Bailey started his opening remarks by noting that the MPC’s decision to hike was not because the economy was strong but only because higher rates were necessary to return inflation to target, and even though he opened the door for further hikes he added that markets should not assume rates are on a long march higher. He also acknowledged the stagflation fears recently voiced by some market participants by saying that policy faces a trade off between weakening growth and higher inflation . Despite the dovish nuances, STIR markets still price an implied cash rate of 1.0% by May which would mean a 25bsp in both March and May (1.0% is the level the BoE previously said they would being outright Gilt selling). Overall, the statement was hawkish, but
the clear dovish undertones from the BoE was a bit surprising and also a bit worrisome for the future outlook.
2. Economic & Health Developments
There is a growing chorus of participants calling for a very tough road ahead for UK growth, and most recent Retail Sales data gave more confirmation to this expectation. Forecasts by the IMF/OECB still sees decent growth differentials, but not everyone shares that optimism (Refinitiv polling data). Even though the solid econ data going into Dec was enough to see the BoE hike, the overall rate expectations already priced in by markets are too ambitious. As long incoming data stay solid it should keep odds for additional tightening alive, but we should be mindful of repricing if the incoming data starts confirming a bleaker picture for growth.
3. Political Developments
The political uncertainty surrounding PM Johnson mean a higher risk premium for GBP. The fallout from the heavily redacted Sue Gray report was limited but reports over the weekend show a growing distrust for the PM from within his own party. The question remains whether enough MPs opt for a vote of no-confidence (if so, that could see short-term downside), but after that the focus will be on whether the PM can survive an actual vote of no-confidence, where a win is expected to be GBP positive and negative for Sterling if he loses. The North Ireland protocol is still in focus in the background with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now, markets have rightly ignored this as political posturing, but of course any actual escalation could see sharp risk premium built into the GBP
4. CFTC Analysis
The CFTC data for GBP was very surprising. Recall that the downside in the GBP only started later during last week, which means that the very big increase in net-short positioning occurred while Sterling was still flying high. The question here is whether this was some political risk premiums building up or part of a bigger change in sentiment as concerns over the UK’s growth outlook continues to surface.
5. The Week Ahead
Just like the EUR, the biggest focus for the week ahead for Sterling will be on BoE talk. The bank tried really hard to get a dovish landing on Thursday, and any additional info and clarity from them will be keenly watched by market participants. With STIR markets pricing in an implied rate of 1.0% by May, one would have thought more upside is warranted for Sterling, but after the dovish undertones as well as the ongoing political challenges things are looking a bit messy for the GBP right now. If we see a similar divergence between ECB and BoE language like we saw at the press conferences that should put further upside pressure on EURGBP.
FUNDAMENTAL BIAS: NEUTRAL
1. Monetary Policy
Hawkish! This sums up the Feb ECB policy meeting. The initial statement was in line with Dec guidance and offered very little surprises (which was initially seen as dovish). However, during the press conference President Lagarde explained that the upside surprises in CPI in Dec and Jan saw unanimous concern around the GC in the near-term and surprised markets by not repeating Dec language which said a 2022 rate hike was unlikely (which immediately saw STIR markets price in a 10bsp hike as soon as June). The president also made the March meeting live, by stating that they’ll use the March meeting to decide what the APP will look like for the rest of 2022 (which markets took as a signal that the APP could conclude somewhere in 2H22. After the meeting we had the customary sources comments which stated that the ECB is preparing for a potential policy recalibration in March (with some members wanting to change policy at today’s meeting already) and added that it is sensible not to exclude a 2022 hike as a possibility and also stated that the ECB is considering possibly ending the APP at the end of Q3 (which would put a Q4 hike in play). Furthermore, sources stated that if inflation does not ease, they’ll consider adjusting policy in March (which means incoming inflation data will be critical). The shift is stance and tone were significant for us to change the bank’s overall policy stance to neutral and to adjust the EUR’s fundamental bias from dovish to neutral as well. Incoming inflation data will be key from here.
2. Economic & Health Developments
Even though the recent activity data suggests the hit to the economy from previous lockdowns weren’t as bad as feared, the additional lockdown measures across Europe has weighed on incoming data. Growth differentials still favour places like the US and UK above that of the EZ and alongside the clear monetary policy divergence means the bearish bias is firmly in place. On the fiscal front, attention is on ongoing discussions to potentially allow purchases of ‘green bonds’ NOT to count against budget deficits. If approved, this could drastically change the fiscal landscape for the EZ and would be seen as a big positive for the EUR and EU equities.
3. Funding Characteristics
As a low yielder (like JPY & CHF), the EUR has been a funding choice among carry trades, especially during 2019 where it was a favourite against high yielding EM. As such, part of the EUR’s upside after the initial risk-off scare in March 2020 was attributed to a major unwind of large carry trades. As more central banks start normalizing policy and rate differentials widen, the EUR’s use as a funding currency could add additional pressure in the med-term , but keep in mind it could also spark risk off upside if some of those trades unwind.
4. CFTC Analysis
Remember that the ECB meeting this past week took place on Thursday, that means that the most recent CFTC update will not include the big jolt higher in the EUR across the board. We would expect next week’s data to show a sizeable increase in large spec net-longs as well as a very big reduction in leveraged fund net-shorts. With so many negatives priced in for the EUR in recent weeks, the unwind could be punchy.
5. The Week Ahead
In the week ahead we have a very light economic calendar coming up for the Eurozone, but we do have quite a few ECB speakers lined up and that will take centre stage for markets. Looking at the moves in both bund yields and the EUR, the ECB members will no doubt have quite a few questions they’ll need to answer and will want to give their own views and opinions. If the ECB thinks the markets overreacted to the message conveyed by President Lagarde, they will want to use this week to get on the wires as much as possible to correct any misplaced expectations. That means President Lagarde’s testimony before the EU Parliament Economic and Monetary Affairs Committee will be scrutinized for any additional details and info, especially with markets now pricing in over 50 basis points of tightening by year-end as well as a Q2 end to QE . Without any strong push back from the ECB in the week ahead will likely lead to a further unwind in short-positioning and should continue to be supportive for the EUR in the very short-term.
GBP
FUNDAMENTAL BIAS: WEAK BULLISH
1. Monetary Policy
Hawkish surprise with a hint of dovish undertones sums up the Feb BoE decision. The bank announced the start of passive QT and also hiked rates by 25bsp as expected, but the vote split was unanimous (9-0) but with a big hawkish surprise being 4 MPC members voting for a 50bsp hike. Inflation forecasts saw a big upward revision to a 7.25% peak by April ( prev . 6.0%) & 5.21% in 1-year ( prev . 3.40%). This initial hawkish statement saw immediate strength for GBP but during the press conference the BoE tried their best to get a dovish landing. Gov Bailey started his opening remarks by noting that the MPC’s decision to hike was not because the economy was strong but only because higher rates were necessary to return inflation to target, and even though he opened the door for further hikes he added that markets should not assume rates are on a long march higher. He also acknowledged the stagflation fears recently voiced by some market participants by saying that policy faces a trade off between weakening growth and higher inflation . Despite the dovish nuances, STIR markets still price an implied cash rate of 1.0% by May which would mean a 25bsp in both March and May (1.0% is the level the BoE previously said they would being outright Gilt selling). Overall, the statement was hawkish, but
the clear dovish undertones from the BoE was a bit surprising and also a bit worrisome for the future outlook.
2. Economic & Health Developments
There is a growing chorus of participants calling for a very tough road ahead for UK growth, and most recent Retail Sales data gave more confirmation to this expectation. Forecasts by the IMF/OECB still sees decent growth differentials, but not everyone shares that optimism (Refinitiv polling data). Even though the solid econ data going into Dec was enough to see the BoE hike, the overall rate expectations already priced in by markets are too ambitious. As long incoming data stay solid it should keep odds for additional tightening alive, but we should be mindful of repricing if the incoming data starts confirming a bleaker picture for growth.
3. Political Developments
The political uncertainty surrounding PM Johnson mean a higher risk premium for GBP. The fallout from the heavily redacted Sue Gray report was limited but reports over the weekend show a growing distrust for the PM from within his own party. The question remains whether enough MPs opt for a vote of no-confidence (if so, that could see short-term downside), but after that the focus will be on whether the PM can survive an actual vote of no-confidence, where a win is expected to be GBP positive and negative for Sterling if he loses. The North Ireland protocol is still in focus in the background with the UK threatening to trigger Article 16 and the EU threatening to terminate the Brexit deal if they do. For now, markets have rightly ignored this as political posturing, but of course any actual escalation could see sharp risk premium built into the GBP
4. CFTC Analysis
The CFTC data for GBP was very surprising. Recall that the downside in the GBP only started later during last week, which means that the very big increase in net-short positioning occurred while Sterling was still flying high. The question here is whether this was some political risk premiums building up or part of a bigger change in sentiment as concerns over the UK’s growth outlook continues to surface.
5. The Week Ahead
Just like the EUR, the biggest focus for the week ahead for Sterling will be on BoE talk. The bank tried really hard to get a dovish landing on Thursday, and any additional info and clarity from them will be keenly watched by market participants. With STIR markets pricing in an implied rate of 1.0% by May, one would have thought more upside is warranted for Sterling, but after the dovish undertones as well as the ongoing political challenges things are looking a bit messy for the GBP right now. If we see a similar divergence between ECB and BoE language like we saw at the press conferences that should put further upside pressure on EURGBP.