“Science has not yet mastered prophecy”
- Neil Armstrong
Amid a sharply deteriorating virus - and by extension economic - backdrop for Europe, ECB President Christine Lagarde delivered the latest update on eurozone monetary policy yesterday. Going into the meeting, expectations of policy action were justifiably low, as a function of near-term, event-driven uncertainties, such as the US Election and Brexit negotiation outcomes, that will likely have a resolution (one way or another) by the December policy meeting. In addition to this, the latest eurosystem staff macroeconomic forecasts will be available to the ECB, and judging by the tone, as well as the content of yesterday’s meeting, it will be these lowered macroeconomic projections that will form the basis of the decision to ease further in December.
Indeed, throughout the press conference, Ms Lagarde referred to the commitment of the governing council to recalibrate ALL of its tools “to respond to the unfolding situation and to ensure that financing conditions remain favourable to support the economic recovery and counteract the negative impact of the pandemic on the projected inflation path.” The problem is that, despite continued reference to the work being already underway to find the optimal recalibration of all of the monetary tools at the ECB’s disposal, and the clear refutation that the is no firepower left in the armoury or tools in the toolbox, that commitment remains, well, unconvincing.
Lagarde continued to reference the need for further national fiscal support and at the same time pledged to defend the transmission mechanism of ECB policy, even though the combination of the two means further distortion of the pricing relative to credit dynamics of debt within the eurozone - a factor that will be exacerbated further by second wave lockdowns across the region. At the same time, she continued to herald the Recovery and Resilience Facility as a “game changer”, when in light of recent developments (not to mention the fact that its ratification is still being heatedly debated in the European Parliament) it is increasingly too little, too late.
Overall, this ECB meeting will go down as a placeholder in the progression of monetary policy. It is likely that the Governing Council were intending to be less committed to action in December, but felt the events of recent weeks forced their hand somewhat. The rest of this year will now be critical for the ECB and Lagarde, not (as she appeared to be positioning for in the Summer) to reframe the ECB’s actions as helping climate change through its Green (ESG) initiatives, but in maintaining its credibility towards its primary mandate, price stability. In the current circumstances of economic shutdowns and restrictions, convincing the markets that recalibration of existing tools is sufficient to recenter inflation at the target level is certainly not an easy job.
So what does this mean for the EUR?
I read a very interesting piece earlier this week on the rationalization of a prophecy - in this instance, of impending doom - from a cult in 50’s America who, when faced with clear evidence in contrast to their prophecies (natural disaster followed by saviour by Alien gods) altered their rationalisation or justification, but at no point questioned that the prophecy itself could be wrong.
As we discussed last week, since April, forecasters have maintained a consistent theme. EURUSD will rise due to:
- relative Covid infection rates (European outperformance),
- growth trajectory outperformance (rebounding from a deeper contraction),
- narrowing of the relative yield differential and,
- the introduction of a joint fiscal instrument, in the form of the European (Pandemic) Recovery and Resilience Fund - not just on the basis of relieving pressure on intra eurozone credit spreads but in attracting long term reserve capital allocation...
...to name a few.
Interestingly the reversal or refutation of all but the last point (at least for now, but we struggle to see the current attraction of increased EUR reserve allocation while bonds pay a negative yield and equities continue to underperform), has not brought with it a reversal of EURUSD forecasts. Obviously, we are not suggesting in any way that such forecast setters are a cult, but we remain unconvinced by these prophecies of doom for the USD. Indeed, far from it.
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