At the end of October, ECB President Lagarde committed the Governing Council to a ‘recalibration’ of its monetary tools amid a pandemic resurgence across the region that shut down economies and significantly increased downside risks to the economic trajectory and their own medium-term projections. As we stated last week. “Central expectations are that the ECB expand the PEPP envelope by around EUR 500B, extend the duration of the programme by up to 12 months and improve the terms of the TLTROs” - so (apart from expecting 3m too much on the duration extension), the recalibration promise was already largely in the price.
Lagarde delivered the broadly expected recalibration in a dramatic list of measures:

(i) An increase in the PEPP envelope by EUR 500B to 1850B, a total envelope that may not be used in full, or topped up further - reiterating the PEPP as the current primary monetary tool;

(ii) Commitment to reinvest maturing PEPP assets until at least 2023;

(iii) Extending the period of favourable terms of TLTRO III by 12 months and adding three new auctions (and expanding participation to 55% of eligible loans);

(iv) extending to June 2022 the collateral easing measures;

(v) Adding a further 4 PELTRO auctions to add to the liquidity backstop;

(vi) Maintaining/extending APP purchases at EUR 20B per month (alongside reinvestments);

(vii) Eurosystem REPO and non-EUR swap lines extended.

However, what the market was really interested in was the ECB narrative on the impact, implications or even acknowledgement of the recent rise in the EUR. In other words, what was less clearly ‘in the price’ was the price itself - or the ECB’s views on the currency.

Last week, we suggested that if the ECB didn’t explicitly attempt to reverse the rally in the EUR, it may well be taken by the market as a green light to buy. In fact, Lagarde appeared very reluctant to get drawn in to talking about the EUR (behaviour likened cleverly on Twitter to the first rule of Fight Club). Suffice to say that “the ECB does not target the exchange rate but monitors developments in FX rates with respect to its impact on the medium-term inflation outlook”. Indeed, during the Q&A Lagarde went further so as to threaten to “watch the EUR very carefully”. She may be looking but, like 50 Cent, EUR is not backing down… At least not yet.

From my perspective, though, that is not the end of the story. While a clean sweep of analysts and commentators confidently forecast a weaker USD for 2021, it remains unclear to me that the USD is fundamentally or structurally flawed, and less so where the investment case, beyond a prospective flow/momentum argument, should suggest EUR outperformance when it has lower (negative) yields, lower trend growth, lower tech innovation (as outsized demand for US tech IPO’s this week may attest), weaker demand, higher trend unemployment, higher NPL’ s (masked, but not improved by the ECB’s generosity in TLTRO offerings) and in some parts significantly higher debt/GDP. Indeed, amid the pronouncements of the new, recalibrated ECB monetary response, there were clear downward revisions to the growth outlook (now -7.3% 2020, +3.9% 2021, +4.2% 2022 and +2.1% 2023 - weaker in all periods than the US) and the inflation outlook - leaving projected inflation at just 1.0% in 2 years’ time, and only 1.4% at the end of 2023: ‘below’, but certainly not ‘close to’ its 2% target. A higher EUR in the near term will likely only make this worse. Of course the USD has some faults, low (but positive) yields and deeply negative real yields are often noted, but we doubt these ailments are enough to keep the USD down for long.

My last thought on today’s ECB meeting is about its personnel. Lagarde emerges from the eurozone political elite and as such perhaps views a stronger EUR as a badge of honour, a tribute to the institution of Europe. Mario Draghi, who arguably emerged from the monetary elite of the eurozone, perhaps viewed the strength of the EUR more cautiously, through its direct implication on the suppression of inflation. Perhaps if it had been Mario Draghi presiding over the meeting today, the 7 policy measures would likely have been less pre-empted (and thus diluted) and possibly even framed against the benefit of a weaker currency in attaining policy targets, when traditional levers are likely at full tilt.