Etikett: FX Research

ECB rule bending to pressure the Euro

ECB rule bending to pressure the Euro ETF SecuritiesFX Research ECB rule bending to pressure the Euro

ETF Securities – ECB rule bending to pressure the Euro

Highlights

  • Markets have repriced the Euro lower, as the chance for a populist Presidential win from Le Pen’s Front Nationale (FN) has increased in recent weeks.
  • The Euro, beset by political uncertainty, has been unable to benefit from the uptick in the underlying economic environment and an improvement in investor positioning in the futures market.
  • Although European Central Bank (ECB) quantitative easing (QE) program appears at its limit, the central bank appears ready to deviate from its ‘capital key’ and buy bonds from more heavily indebted nations, in turn putting further pressure on the Euro later in 2017.

Politics repricing the Euro

Analysts have repriced consensus forecasts lower for the EUR/USD during 2017, as political uncertainty threatens to break-up the Eurozone. At the end of 2016, consensus forecasts centred around 1.07 by end Q1 2017, compared to just 1.04 currently. We expect that the Euro should end Q1 around 1.08 as political uncertainty fades.

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The Euro has been battered by political uncertainty and has been unable to benefit from the improvement in the underlying economic environment. The Bloomberg Eurozone Economic Surprise Index suggests that the Euro could, in the absence of the ECB’s QE activities and the current uncertainty surrounding the political environment, be significantly higher against the USD.

Although populism and an increasingly insular voter attitude is a distinct similarity between the US and the Eurozone, the result for the currency could be a stark contrast. After vowing to bring back the French Franc, the potential for FN’s Le Pen to win the French election could prompt the Euro to move to parity against the US Dollar, a contrasting result compared to the US Dollar strength after the Trump Presidential victory. Nonetheless, EUR/USD parity on the back of a Le Pen victory is not our base case.

Economics drives policy differences

There are also other differences on an economic level between the US and Europe: unemployment across the Eurozone remains elevated, and excess spare capacity is likely to keep wage growth muted for some time. With excess labour market capacity, there is unlikely to be the pressure on core inflation that we expect to occur in the US later in 2017.

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However, inflation expectations have been rising on a global basis. The unwind of oil price effects has pushed headline prices higher, even beyond our bullish view and well beyond consensus expectations for the Eurozone. Eurozone inflation reached the highest level since March 2013, and now is in line with the ‘close to or below’ the 2.0% ECB target. Importantly inflation is unlikely to spike above the central bank’s target in coming months, and the ECB will ‘look through recent upturns in headline inflation’.

ECB nearing its limit

While the US Federal Reserve is taking a hawkish approach, the ECB is firmly in accommodative support mode with monetary policy.

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The ECB’s balance sheet has never been larger. However, the ECB is nearing the limit of its QE activities, with growth in its balance sheet fading. However, there are signs that the central bank could move outside the current scope of the asset purchase scheme to once again boost its balance sheet and the Eurozone money supply.

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Although the Euro should benefit if the ECB was able to cease its bond buying without any significant dislocations in interest rate markets by year-end, the potential for fresh policy pressure has weighed on the common currency.

The ECB’s latest Account of the monetary policy meeting noted the potential for the central bank to make ‘limited and temporary deviations’ from its capital key. This suggests the possibility of moving away from a broad GDP based bond buying scheme towards a debt weighted scheme. Such a move would advantage more heavily indebted nations such as Italy, but pressure the Euro in H2 2017.

What are markets pricing?

Futures market positioning has rebounded from extremely depressed levels, but investors remain net short of the Euro. However, the Euro is more depressed than what the historical relationship indicates. In contrast, options market pricing is highlighting the Euro is expected to be the second worst performer against the USD in the G10. Options pricing is the most pessimistic about the Euro’s valuation since June 2016.

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We expect the Euro to strengthen to around 1.08 in coming months as it becomes more apparent that Le Pen’s FN party is unlikely to win the French Presidency. Despite this volatility will remain, and further ECB asset purchases and ‘rule bending’ could see the Euro move back toward current levels in H2 2017.

Important Information

The analyses in the above tables are purely for information purposes. They do not reflect the performance of any ETF Securities’ products . The futures and roll returns are not necessarily investable.

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EU referendum unveils Sterling opportunity

EU referendum unveils Sterling opportunity

ETF Securities FX Research: EU referendum unveils Sterling opportunity

Summary

  • Gambling odds turn favourable for the ‘remain’ camp as political polls show tight referendum result.
  • Adverse economic impact is expected to outweigh regulatory and fiscal benefits of the UK leaving the EU.
  • Pessimistic sentiment is at the highest level on record in the FX options market for EUR/GBP. GBP should rebound.

Sentiment turning

According to the latest polls, the gap has narrowed over the past few months in favour of Britain leaving the EU.

The current polling suggests that around 44% of voters will support staying in the EU, with 42% in the ‘leave’ camp, leaving a significant undecided proportion. According to the website oddschecker, the referendum result is likely to be more stark than current polling indicates. Current betting odds across a number of online gambling sites suggest 78% of gamblers are expecting Britain to stay in the EU.

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However, phone and online polling have seen diverging trends in recent weeks. Evidence indicates that when voting intentions are measured and there isn’t a ‘don’t know’ option, most undecided voters will choose the status quo, in this instance, for Britain to remain in the EU. Most internet polls have as a standard option, a ‘don’t know category and that is partially to blame for the divergence in views between internet and phone polls. While phone polls show a generally larger divide between the two camps (in favour of ‘remain’), recent evidence has been showing that the gap is narrowing between the ‘remain’ and ‘leave’ alternatives.

Will history repeat itself?

In 1975, UK voters were given the choice to stay or leave the European Economic Community. Voters were faced with the question, ”Do you think the UK should stay in the European Community (Common Market)?”. The 2016 question is very similar: “Should the United Kingdom remain a member of the European Union or leave the European Union?”

In 1975, the final result showed that there was 67% support from voters for staying in the EC, in line with current estimates ‘remain’ campaign.

Economic impact

The Bank of England have also weighed in on the June 23 vote, noting that growth could be impacted in the near-term. The central bank notes that ‘uncertainty relating to the EU referendum has begun to weigh on certain areas of activity’ with ‘capital expenditure and commercial property transactions…being postponed pending the outcome of the vote.’ The IMF has also indicated that a ‘leave’ vote would be damaging, with its chief economist stating that ‘a Brexit could do severe regional and global damage by disrupting established trading relationships.’

According to a poll by Greenberg Quinlan Rosner, the three most important issues for voters are the economy, immigration and the control of our (UK) laws. While the ‘leave’ camp appears mostly concerned with either burgeoning regulatory framework or immigration, financial markets are focussed on the adverse impact on growth via the external account. The European Union accounts for 45% of UK exports and 53% of its imports. Although the UK has a two year window to re-negotiate trade deals, bureaucrats generally move at snail’s pace. Such a timeframe seems a very tight window for a major project, with government efficiency growth very close to zero. US President Obama has indicated that a trade deal with the US could take as long as 5-10 years to reach agreement and that the UK would ‘move to the back of the [negotiating] queue’. Such comments highlight strong global concerns over the potentially adverse impact on financial stability.

There are modest fiscal benefits expected from not contributing to the EU budget if the UK leaves the EU. Depending on the final relationship of Britain and the EU, the Centre for Economic Policy Research calculates a best case scenario of a 0.31% saving in per capita income, not enough to offset the negative trade effects contributing to a decline of almost 3% in incomes.

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However, any fiscal benefit could be offset by the need to create new administration regarding implementation of new domestic regulation and trade agreements.

HRM Treasury’s own calculations indicate that the UK would be between 3.4% and 9.5% of GDP better off remaining inside the EU within 15 years. The wide dispersion of the GDP range depends on the eventual structure of trade that Britain would adopt with the EU if it left the economic union.

Several economic consultancies have calculated the potential impact should voters decide to leave the European Union. On average a result of a leave vote is expected to make Britain worse off by between 0.1% and 5.5%.i

What’s the FX market saying?

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Against the USD, GBP recently has experienced a modest bounce from multi-year lows. Against the Euro, GBP is hovering at the weakest level in the past 12 months. Negative sentiment is priced in as volatility has weighed on GBP.

Options market pricing is indicating that bearishness is at the highest levels in over a decade for GBP against the Euro.

Volatility is the status quo

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The risk of Britain exiting the EU has seen the cost to insure against a British sovereign default rise by over 100% since the beginning of 2016, another reason for GBP weakness.

Where to next for GBP?

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With so many voters as yet to decide which way to vote, volatility will remain elevated for GBP crosses and will likely keep the pound under some pressure against major currencies. However, such depressed levels of GBP opens up buying opportunities in the medium term as uncertainty fades.

Historically, steep falls in the Pound have presaged strong rebounds. The subsidence of volatility following the financial crisis and the Scottish referendum, led to strong gains for GBP against the Euro. In the four months after the financial crisis, GBP rallied 4.3% against the Euro. Indeed, we expect that the EUR/GBP is the more favourable cross to implement views of Britain remaining within the EU, with the US expected to tighten rates further in 2016 and the ECB keeping the Euro weak with aggressive policy stimulus.

Important Information General This communication has been issued and approved for the purpose of section 21 of the Financial Services and Markets Act 2000 by ETF Securities (UK) Limited (“ETFS UK”) which is authorised and regulated by the United Kingdom Financial Conduct Authority (the “FCA”).

The information contained in this communication is for your general information only and is neither an offer for sale nor a solicitation of an offer to buy securities. This communication should not be used as the basis for any investment decision. Historical performance is not an indication of future performance and any investments may go down in value.

This document is not, and under no circumstances is to be construed as, an advertisement or any other step in furtherance of a public offering of shares or securities in the United States or any province or territory thereof. Neither this document nor any copy hereof should be taken, transmitted or distributed (directly or indirectly) into the United States.

This communication may contain independent market commentary prepared by ETFS UK based on publicly available information. Although ETFS UK endeavours to ensure the accuracy of the content in this communication, ETFS UK does not warrant or guarantee its accuracy or correctness. Any third party data providers used to source the information in this communication make no warranties or representation of any kind relating to such data. Where ETFS UK has expressed its own opinions related to product or market activity, these views may change. Neither ETFS UK, nor any affiliate, nor any of their respective officers, directors, partners, or employees accepts any liability whatsoever for any direct or consequential loss arising from any use of this publication or its contents.

ETFS UK is required by the FCA to clarify that it is not acting for you in any way in relation to the investment or investment activity to which this communication relates. In particular, ETFS UK will not provide any investment services to you and or advise you on the merits of, or make any recommendation to you in relation to, the terms of any transaction. No representative of ETFS UK is authorised to behave in any way which would lead you to believe otherwise. ETFS UK is not, therefore, responsible for providing you with the protections afforded to its clients and you should seek your own independent legal, investment and tax or other advice as you see fit.