There is a strong possibility the euro will suffer a sharp fall following the ECB’s monetary policy meeting today, with little chance of a significant move up.
Investors must remember the euro has had an excellent year, moving from $1.04 to $1.18 – a strong rally in excess of 13%. The market has already anticipated some policy normalisation on the improving economic performance in Europe, so something dramatic is likely going to be needed to surprise investors.
Speculative positioning in the euro has also moved from being very short to very long, which also shows the market has more than priced in the likely evolution of eurozone monetary policy. These investors are not committed holders and will be quick to unwind positions should policy disappoint. We believe there is a high probability Mario Draghi and the ECB frustrate euro bulls today. With inflation so low, the central bank has no reason to feel any pressure to be aggressive.
Therefore, we believe the euro has gotten a little ahead of itself. It is likely to take a minimum of six months to taper off existing purchases and – if the Fed is anything to go by – a further substantive period before interest rates rise. At the same time, the Fed is likely to be increasing rates and unloading bonds on the market, which should be positive for the dollar.
While fundamentally the euro screens as slightly undervalued – with further support from robust trade flows – we believe this will be insufficient in providing much support in the short term. Nevertheless, the reaction on European government bonds is likely to be more muted, as prices remain underpinned by QE and pension fund purchases.
Matthew Brittain, macro analyst, Sanlam Strategic Bond Fund