Lagarde gives US dollar what it needed—a peak

The US dollar might just have peaked, and if it has then a blog post by Christine Lagarde has a lot to do with it. The president of the European Central Bank chose to post an essay to the ECB website, effectively setting out a new and more hawkish policy. Both the policy itself and the fact that she had felt the matter so urgent that she needed to launch it online between meetings helped strengthen the euro significantly against the dollar.
Effectively, she outlined a rationale for the ECB to turn away from a decade of aggressively dovish monetary policy and committed the bank to two interest rate hikes by September, which would bring its overnight interest rate back up to zero. That is still a lenient monetary policy by any definition, but after years of negative rates it’s a big deal.
Here is the key passage from her blog post:
“Even when supply shocks fade, the disinflationary dynamics of the past decade are unlikely to return. As a result, it is appropriate for policy to return to more normal settings rather than those aimed at raising inflation from very low levels…With the inflation outlook having shifted notably upwards compared with the pre-pandemic period, it is appropriate for nominal variables to adjust — and that includes interest rates. This would not constitute a tightening of monetary policy; rather, leaving policy rates unchanged in this environment would constitute an easing of policy, which is not currently warranted. Against the backdrop of the evidence I presented above, I expect net purchases under the APP to end very early in the third quarter. This would allow us a rate lift-off at our meeting in July, in line with our forward guidance. Based on the current outlook, we are likely to be in a position to exit negative interest rates by the end of the third quarter.”
It would be hard to make that much clearer, even if she could have stated it a little more directly. The ECB has form for effectively promising monetary policy moves months in advance. Jean-Claude Trichet, one of Lagarde’s predecessors, developed a code with reporters; if he said in a press conference after a board meeting that the ECB had an attitude of “extreme vigilance,” that meant there would be a rate hike at the next meeting. In 2022, “extreme vigilance” means getting rates back up to zero within four months.
The reasons for concern about the eurozone economy are legion, even before a neighbour was invaded in a land war and access to energy was thrown into doubt. But even if fear for the future has a sound foundation, confidence in the business sector remains strong.
Strong macroeconomic news combined with a more hawkish Lagarde to push up estimates for target rates by the end of this year. The first three months saw a wide gap open between the Federal Reserve and the ECB, with the estimated spread of US over eurozone overnight rates as of the central banks’ meetings in December this year rising by more than a percentage point. The difference between the two central banks now seems to have been priced in, and the belief is that they may even converge a little. That weakens the dollar, which is a relief to more or less everyone. A lower dollar should buoy US corporate profits by flattering multinationals’ overseas earnings.
Later in the day, comments from Raphael Bostic, head of the Atlanta Fed, that a pause in rate hikes as early as September might make sense represented the first hint in a dovish direction from the Fed in some months, and helped ensure that the euro maintained its gains.

—Bloomberg