Hawkish sums up the ECB’s Feb decision. 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 nearterm 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
Recent activity data suggests the hit from lockdowns weren’t as bad as feared, the Omicron restrictions weighed on growth. Differentials still favour the US and UK above the EZ. The big focus though is on the incoming inflation data after the ECB’s recent hawkish pivot at their Feb meeting. 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 can drastically change the fiscal landscape and would be a positive for the EUR and EU equities.
3. Geopolitics
The Russian invasion of Ukraine opens up a lot of uncertainty for the EUR. On one hand, the decision to ban certain Russian banks from SWIFT was expected to impact the EU negatively, but the decision to freeze CBR assets means the expected FX reserve sales of Euros (to try and prop up the RUB) might not happen. The other consideration is energy, with the SWIFT bans, any restrictions on energy sales from Russia would put pressure on already high inflation and increases stagflation risks of higher inflation but falling growth. That does cloud the med-term outlook for the EUR and means we are happy to hold onto a neutral bias for now.
4. CFTC Analysis
Participants are building into EUR longs. Large specs have seen 9/10 week of net increases in longs, asset managers have seen 10/12 weeks of net increase in longs and leveraged funds have reduced net shorts for 11 weeks in a row now. It’s safe to say that the sentiment for the EUR has improved given positioning data. However, the risk here is also that a lot of new bullish sentiment could have built up at the wrong time.
5. The Week Ahead
It’ll be a difficult juggle for the EUR next week amid very important econ data and geopolitics. Monday’s open can be messy, as further sanctions on Russia over the weekend is a negative for the EUR but freezing assets from the CBR could mean less chance of dumping EUR reserves to prop up the RUB. Also keep USD liquidity squeezes in mind as a big drain on USD liquidity could see the Fed opening up swaps and could end up pressuring the USD & supporting the EUR. On the data side there will be a lot of focus on Wednesday’s HICP print. The upward surprise in Jan’s HICP was enough to see unanimous concern among the GC according to Pres Lagarde. This past week, ECB’s Lane said the Ukraine crisis presents a big risk to much higher inflation for 2022, and that comes amid already much steeper upwards projections to staff forecasts. Thus, an upward surprise to this week’s data would put more pressure on the ECB to go ahead with a possible policy recalibration at the upcoming March meeting and should be a positive input for the EUR (despite the geopolitical risks). Market implied rate expectations have dropped to just above 30bsp, which means an upside surprise in price pressures can spark some higher repricing. With so many negatives priced into the EUR over the past few months, we still hold to the view that the EUR could perform well relative to the USD and GBP if the ECB tilts more hawkish as we’ve arguably been getting very close to a state of peak hawkishness for the Fed and BoE.
USD
FUNDAMENTAL BIAS: BULLISH
1. Monetary Policy
The Jan FOMC decision was hawkish on multiple fronts. The statement signalled a March hike as expected, but Chair Powell portrayed a very hawkish tone. Even though Powell said they can’t predict the rate path with certainty, he stressed the economy is in much better shape compared to the 2015 cycle and that will have implications for the pace of hikes (more and faster). Furthermore, he explained that there is ‘quite a bit of room’ to raise rates without damaging employment, which suggests upside risks to the rate path. A big question going into the meeting was how concerned the Fed was about recent equity market volatility . But the Chair explained that markets and financial conditions are reflecting policy changes in advance and that in aggregate the measures they look at isn’t showing red lights. Thus, any ‘Fed Put’ is much further away and inflation is the Fed’s biggest concern right now. The Chair also didn’t rule out the possibility of a 50bsp hike in March or possibly hiking at every meeting this year, which was hawkish as it means the Fed wants optionality to move more aggressive if they need to. We didn’t get new info on the balance sheet and Powell reiterated that they’re contemplating a start of QT after hiking has begun and they’ll discuss this in coming meetings. Overall, the tone and language were a lot more hawkish than the Dec meeting and more hawkish than consensus was expecting.
2. Global & Domestic Economy
As the reserve currency, the USD’s global usage means it’s usually inversely correlated to the global economy and global trade. Thus, USD usually appreciates when growth & inflation slow (disinflation) and depreciates when growth & inflation accelerates (reflation). With expectations that growth and inflation will decelerate this year that should be a positive input for the USD. However, incoming data will also be important in relation to the ‘Fed Put’. There are many similarities between now and 4Q18, where the Fed were also tightening aggressively going into an economic slowdown. As long as growth data slows and the Fed stays aggressive that is a positive for the USD, but if it causes a dovish Fed pivot and lower rate repricing it would be a negative input for the USD.
3. CFTC Analysis
With peak hawkishness for the Fed arguably close to baked in for the USD, it’s been interesting to view the positioning unfold in the past few weeks. Even though the USD remains a net-long across large specs, leveraged funds and asset managers, it seems the EUR’s attractiveness has continued to grow and could mean more downside for the USD unless the Fed surprises even more hawkish, and the ECB stays dovish. Also keep safe haven flows in mind as the current geopolitical tensions does add another layer of complexity to the USD.
4. The Week Ahead
Busy week ahead on the data front, with the ISM Manufacturing and Services, ADP national employment and of course the big one with NFP coming up on Friday. The recovery in recent data (Retail Sales & Industrial Prod) suggests a very similar covid bounce like we saw with Delta, and that point to a possible similar bounce in the ISM data this week. However, it’s important to keep in mind the growth trend is still tilted lower for the rest of 2022. Moving on to the jobs data, even though the headline ADP and NFP prints will as always garner attention, the bigger focus for the jobs data will arguably fall to the inflation prints like the Average Hourly earnings . The question is whether the data could beat enough to see markets pricing back a 50bsp hike, as probabilities for a 50bsp hike was sitting at just 26% on Friday. For now, it seems unlikely that a bigger than expected beat would seal the deal for a 50bsp move, especially given the recent uncertainty thrown into markets with Russia’s invasion of Ukraine. A lot can happen at the open given the weekend’s reports that the West has banned certain Russian banks from SWIFT and has also said they will freeze assets from the CBR . Given the volatility this could create in EM with the RUB. However, even though the geopolitical situation will be important for the safe haven USD, with the US and the Fed being more isolated, the data will still be important, with the bigger reaction expected on a miss as opposed to a beat, given the amount of hawkishness already priced for the Fed. Just be mindful that the ban on SWIFT could create a slowdown in USD availability which could see the Fed being forced to open up additional swap lines to ease demand, that was a negative when announced in 2020 and can be a trigger for lots of downside (with the EUR a possible big benefactor if that’s the case).