ECB Meeting Preview: Potential Volatility ahead for Euro crosses
The ECB will make their policy decisions at 12:45 BST/21:45 AEST and the press conference will follow shortly thereafter at 13:30 BST/22:30 AEST. I’m not expecting any changes to policy tools at this meeting (interest rates and asset purchases). No surprises on that front, but there is still the risk of a miscommunication during the press conference. Lagarde should try to use this meeting as a bridge meeting to June with a reflection and stock take on the effectiveness of their front-loaded asset purchases from their March meeting. To put it in culinary terms, this meeting will be more like the starter before the main course in June, where we will receive the updated economic forecasts (I expect some chunky upgrades) and have a much better read on how the vaccine rollout has progressed as well as disbursement of the recovery fund. The focus is shifted to June where the big question mark is: Will the pace of PEPP be increased, decreased or kept as is?
Back in March, when yields had increased substantially, there were concerns that financial conditions were tightening. This was a spillover effect from the US bond market and wasn’t reflective of European economic fundamentals. In an attempt, to stem this and not handbrake the recovery, the ECB indicated they would increase their purchases significantly. So what’s happened since then?
Easy financial conditions have been preserved. Not much has happened in bond land as yields stopped rising over in the US and Europe has tracked this move. Inflation expectations have been picking up across Europe, which combined with stable nominal yields has led to a compression in real yields. Major European Equity markets are buoyant. The euro, however, has strengthened marginally in April, which does tighten financial conditions a tad, but when weighed against the other factors mentioned above the net effect is not concerning at all.
So now that we know the lay of the land, what is key for this meeting? Well just today we received an update on the latest weekly PEPP purchases and they have come in quite low and a decrease on than last week’s amount. This is going to have to be addressed at this meeting as now credibility is beginning to be questioned – there’s only so much jawboning that one can do. If it isn’t addressed adequately then bond market participants could challenge the ECB, risking a mini taper tantrum which would show up in a higher EURUSD value, causing a headache for the ECB in supporting the recovery and getting inflation back up to 2%. I’m sure we’ll be hearing the word “flexibility” again. This meeting could provide us with some more insight into the debate currently taking place within the ECB. Governing Council members Klaas Knot and Robert Holzmann have both raised the idea of bond-buying being tapered in the later stages of H2 21. Christine Lagarde response to these growing calls from the Hawkish camp will be an interesting aspect of this meeting. Last week Wednesday, she took a cautious approach and stated the Eurozone economy is on two crutches namely, fiscal and monetary and these crutches should not be taken away prematurely until a full recovery is on the cards.
As mentioned above traders will be using this meeting to try and look for any clues on how the ECB may change their PEPP policy in June. It’s difficult to say at this point, given how dependent it will be on the progress made in achieving the target of vaccinating 70% of the European population. Additionally, how the court case with regards to the EU recovery fund pans out and if a reopening can take place in time for Europe’s summer tourist season. These are all factors which we’ll know far more about closer to June. It’s a difficult balancing act for Lagarde - not opening the stimulus taps too aggressively and undermining financial stability as well as not tightening prematurely. In my opinion, I lean more towards leaving the purchase pace as is. Risks to the Growth outlook are more symmetrical now, with the recent increase in the pace of vaccinations and a positive spillover from US fiscal stimulus it should make the ECB less nervous regarding higher yields as it will reflect an improving growth outlook. It wouldn’t really make sense to increase the pace of purchases when the outlook is going to probably look a lot more positive. However, if there are more hiccups with the vaccine rollout and the court case drags on, delaying the deployment of the recovery fund then an increase in the pace of purchases becomes far more likely.
After the ECB meeting, on Friday we will receive the flash April PMI for the Eurozone. The expectation is for a decrease from March’s number on the back of lockdowns not being lifted and new restrictions in Italy, Germany and France. However, if numbers aren’t as weak as expected then we could see a bid in EURUSD.
So far EURUSD seems to be holding above the 50-day SMA, having a go at the key 1.205 horizontal resistance level. The RSI has comfortably pushed through the 52 resistance level, which capped prior rallies in the downtrend and is now marching higher towards overbought levels. If price rolls over from the 1.205 level and holds the 1.19 and pushes higher again we could see an inverted head and shoulders pattern begin to form (typically bullish). This meeting could be catalyst to drive a new short-term price move. Click here to express a view.