ECB doves sour euro rally with pushback against tapering bets

Bloomberg

The euro’s charge towards a three-year high is stumbling as the European Central Bank quashes expectations that it’s anywhere near paring back emergency stimulus.
The ECB is increasingly expected by economists and investors to extend its elevated pace of emergency bond-buying at a June meeting, even as the continent’s vaccination program surges forward and economy rebounds. That’s putting a damper on prospects for further gains in the common currency, which has risen about 4% against the
dollar from a trough in March.
Policy makers including Executive Board member Fabio Panetta have signaled a willingness to shrug off near-term inflationary spikes and keep policy loose for the time being. On the other side of the Atlantic, counterparts at the Federal Reserve appear to have made peace with the need to eventually wind down their bond buying.
“For a significant rise in the euro I suspect we’ll need to see some hawkish noises from the ECB,” said Mike Riddell, portfolio manager at Allianz Global
Investors. “But tapering aggressively puts the stability of the euro-zone bond market at risk, and rate hikes may never happen at all.”
Global central banks are quietly starting to tip-toe away from the emergency monetary settings put in place during the coronavirus crisis, and markets are reflecting slowing asset purchases and rate-hike expectations accordingly. The ECB, which has struggled for years with lackluster inflation, looks increasingly set to lag the pack — while the Fed could be next in line to deliver a hawkish surprise.
Traders are growing jittery at any hint of policy shifts. The pound spiked after Bank of England policy maker Gertjan Vlieghe detailed many scenarios for the UK economy.
Also this week, South Korea’s central bank Governor Lee Ju-yeol signalled a shift when he said officials are preparing for an “orderly” exit from record-low interest rates at some point as the economy recovers. Canada and New Zealand have also flagged such moves, while Federal Reserve officials have been steadily shifting their tone.
The diverging signals out of Washington and Frankfurt are prompting strategists from Rabobank and Credit Agricole SA to brace for the euro to decline by as much as 3% from current levels against the greenback.
Options markets show clashing signs. Risk reversals — a barometer of market positioning and sentiment — point to investor optimism on the euro. Implied volatility shows low expectations for the ECB’s next meeting in June.
While Allianz’s Riddell moved from a short euro position to neutral as the continent got its vaccine push on track, he says there’s little prospect of fresh impetus coming from the ECB, and faster inflation in the bloc is unlikely to last beyond this year.
ECB officials fear a stronger euro could harm the still-fragile European recovery, and say they’re keeping an eye on the currency. Wage pressures are weaker in the euro zone and the recovery isn’t as broad-based as in the US, according to Jonathan Peterson, markets economist at Capital Economics, factors which will likely weigh on the common currency.
At the same time, bond markets are projecting European normalisation, with yields
expected to turn positive as
the continent proceeds with vaccines and reopening.

Most of the increases in German borrowing costs reflect a pickup in domestic demand and the expectation it will continue, according to Bloomberg Economics. Growth estimates from economists surveyed by Bloomberg show more room for upside in the euro zone compared with the US.
And some analysts, including those at Deutsche Bank AG, Citigroup Inc. and Bloomberg Intelligence, still see the euro reaching $1.25 or higher in the coming months. George Saravelos, global head of FX research at Deutsche Bank, predicts further upside if the region’s data continue to strengthen. A Fed announcement on tapering might not be interpreted as a hawkish signal, he said.
Even so, the rise of coronavirus variants remains a threat to the region’s economy, and history shows the ECB proceeds more cautiously than the Fed.
“When you look at expectations in the United States and expectations in the euro area, we are not on the same page,” ECB President Christine Lagarde said in April. “It would clearly predicate that we will not operate in tandem with the Fed. I think that’s very much a given — it’s not me looking into a crystal ball.”