The April ECB meeting has all chances to become a factor of support for EURUSD. At the March meeting, Lagarde failed to show off ECB’s firepower at a critical time for the economy, forcing investors to demand extra returns for holding Euro (i.e. creating risk premium in it). They obviously expected “whatever it takes” tone from the ECB president but Lagarde didn’t live up to expectations. This ambiguity became a bearish factor for EURUSD. If Lagarde elaborates properly on ECB’s rescue plan, including details on the pandemic asset purchase program (PEPP) the risk premium in Euro will probably vanish helping the currency to outperform USD in the near-term.
Two key aspects of the meeting to pay attention are updates on pandemic asset-buying program (PEPP) and ability of Lagarde to reassure markets that ECB has enough ammo and won’t hesitate to use it. It is clear that the policy response of the ECB in March was less profound compared to the Fed:
And although interest rates cuts and increase of QE operations should normally lead to decline in national currency this doesn’t happen when economic conditions do not favor expansion of credit (which is the main driver of money supply growth) so positive QE effects (like bringing ease to funding markets) become a factor of currency strengthening, leading to capital inflows! The Fed and dollar performance in March perfectly support this reasoning.
The PEPP program, which is so much talked about now, can be increased both in breadth (from the current 750 billion euros to 1.250 trillion) and in depth (including the purchase of bonds of the so-called fallen angels – former investment-grade companies falling into speculative category). If this happens at the meeting on Thursday, it will be a big bullish factor for the euro, but given that updated economic forecasts from the ECB will not appear until June, the expansion of PEPP may be delayed. One of the simple but useful indicators of risk for the Eurozone economy is the yield on Italian bonds and its recent decline from 2% to 1.7% suggests that the anxiety about problematic debtors has somewhat eased. This increases chances that the ECB won’t rush to expand PEPP in April, but a signal that this will be done in July will be nevertheless a moderate positive factor for EURUSD.
As for the press conference with Lagarde, attention should be paid to the comments regarding inflation outlook, economic growth, interest rate and QE paths. In March, Lagarde surprised markets with a rather neutral statement that “inflation is expected to rise in the medium term,” so Lagarde’s remarks on Thursday that the ECB is moving away from the inflation target is a baseline scenario and should not be surprising. No changes are expected in the interest rates and QE; comments on economic growth are expected to focus on confirming sharp slowdown in March and April. In general, the trading idea for the meeting on Thursday concentrates on Lagarde’s ability to correct communication mistakes made at the March meeting.
Reducing distance between the interest rates of the Fed and the ECB, declining demand for dollar as a safe haven may determine fundamental advantage of EUR over USD in the medium term.
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