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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French primaries, another hit to the polls

French primaries, another hit to the polls

For the first time in the history of the right wing party, the French are able to have their say and vote for the Republican candidate for the presidential election in May 2017. These open primary elections happen at a time when populism is rising across the developed world. After the UK and the US, the focus is now on Europe. French political parties acknowledged the threat from the far-right chaired by Marine Le Pen. The winner of the primaries will most likely face Le Pen next year and potentially become the next president of the French Republic. French primaries, another hit to the polls

Last Sunday, more than 4 million voters gathered at polling stations in France, or on their computers for French living abroad, to choose the one who will highly likely face Marine Le Pen at the French presidential election in May 2017. Following the EU referendum and US election, the centre-right party (renamed the Republicans) is taking the rise of populism very seriously with these primaries a strategic move to guarantee the soon elected candidate its legitimacy in the race.

The results of the first round held yesterday were another hit to pollsters. While polls have consistently pointed Juppé as best placed for being the next French president with Sarkozy as his main opponent, Fillon made a surprising comeback and won the first round with 44% of the vote. Juppé only managed to get 28% and Sarkozy bowed out. The second round scheduled this Sunday is now between Fillon and Juppé with a debate scheduled for this Thursday. The possibility for Juppé becoming president is however much slimmer.

Juppé is a conservative. Fillon is more liberal. Both however take a similar approach on security and immigration issues. The successful candidate needs to be charismatic and well-prepared to promote their perspective on these key issues ahead of next year’s presidential debate in order to prevent a Frexit. Beyond the battle of rising populism, voters this Sunday should keep in mind that now more than ever, France needs a strong president and government that will be able to bring the country back to its feet socially and economically. People who will vote this Sunday will in this way be voting for their next president.

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Edith Southammakosane, Multi-Asset Strategist at ETF Securities

Edith is a director, multi-asset strategist at ETF Securities, specialised in investment strategies across commodity, equity, currency and fixed-income. Edith has 9 years of experience in the ETP industry, with exposure to different aspects of the business, from product management to research and investment strategy. Prior to joining ETF Securities, Edith started her career working for Lyxor Asset Management in Paris as Marketing assistant. Edith holds a Master in Management with a major in Risk and Asset Management from the EDHEC business school (France).