Despite the myriad European Central Bank jawboning remarks heard in recent weeks, and more importantly in the past two days, the euro, trading around $1.3825 Monday, was barely one percent below the 2014 peaks near $1.3967, seen March 13.
This has left traders to wonder if the ECB’s efforts to talk the euro down are seeing “diminishing effects.”
“It’s not the first time we have seen comments like this,” said one U.S. trader.
“Yeah, it’s Draghi,” he said, but “I can’t get excited until something happens.”
The trader referred to concrete ECB monetary policy changes, which may or may not eventually involve quantitative easing.
On Saturday, ECB President Mario Draghi said further strengthening of the euro would require further monetary policy stimulus. This was Draghi’s strongest and clearest warning yet over the euro’s continuous rise against other major currencies the past 12 months.
Speaking at a press conference on the sidelines of the International Monetary Fund and World Bank spring meetings in Washington, Draghi said that while he has always mentioned the exchange rate is not a policy target, the euro’s strength in recent months shows it is becoming more and more important for price stability and could trigger looser monetary policy.
“We have looked at how important the evolution of the foreign exchange rate was the last year to lower the inflation rate to the levels where it is now” he said.
“Now we know it is not the only element, but an important element. In a sense, if you want monetary policy to remain as accommodative as it is today, the further strengthening of the exchange rate, would require a further monetary policy stimulus” he added. (See MNI mainwire at 7:16 a.m. ET for further details).
Draghi’s concern was echoed by ECB Governing Council member Josef Bonnici, who over the weekend said, that while the euro “has eased slightly since the last Governing Council meeting, but is still at a higher level than would be desirable if net exports are also to support economic growth in the Eurozone.”
Earlier Monday, ECB Governing Council member Christian Noyer strongly rejected the notion that the central bank would struggle to find sufficient securities to buy if a QE program were launched.
On QE, Noyer said, “If we want to go to buying securities, which is really the heart of QE then, of course, we can … buy private ones, we can buy also sovereign ones.”
He noted that the ECB had bought sovereign debt in the past, notably through its Securities Market Programme, adding, “It is absolutely possible to intervene on the secondary market.”
Asked if the ECB would step in if the euro were to rally to $1.50 versus the dollar, Noyer said he had nothing to say on the level.
“The (euro) appreciation that has taken place during the last year was not appropriate,” he said.
He added that “we still hope it might correct itself naturally.”
“We could act whenever we find that it is necessary to ensure the safe return path to our objective of price stability,” he said.
Carl Weinberg, chief global economist at High Frequency Economics in Valhalla, New York, saw FX intervention as “the most viable tactic for large scale QE on short notice,” in terms of choices before the ECB.
As for QE, “constitutionally and politically, the ECB faces what we think are insurmountable challenges to buying sovereign bonds for its balance sheet (doing so may prompt legal challenges by member states),” he said.
And “allocating bond purchases across sovereign issuers would require political decisions that exceed the ECB’s mandate,” Weinberg noted.
The ECB can’t really buy corporate bonds (“no legally defined place on ECB balance sheet”) and ABS are “non-existent,” so other than FX and gold, HFE can’t see what other asset class the ECB could buy other than FX “to bulk up its balance sheet.”
Foreign exchange intervention QE would have a different effect on the eurozone economy than pure bond buying QE, with unsterilized FX intervention (buying of dollars, yen and sterling, maybe C$ and CNY) boosting banks reserves, and perhaps forcing banks to lend more.
But QE via FX “would not directly lower yields and interest rates,” Weinberg said. HFE remained watchful for unsterilized ECB FX intervention, seeing “no other practical avenue for the ECB.
On the FX front, the euro topped out at $1.3906 Friday, and closed the week at $1.3885.
This week, in the wake of the various comments on the weekend and Monday, the euro bottomed around $1.3808 earlier and then stabilized at slightly higher levels.
At the lows, the pair was only 0.7% down from Friday’s peaks. At current levels near $1.3825, the euro is up 0.6% year-to-date and up 6.1% from the $1.3036 closing level seen April 15, 2013.
Traders were not overly surprised that the euro was not more on the defensive, with the announcement effect of these remarks having “diminishing returns.”
The ECB is facing a tough battle, said Bob Lynch, head of G10 FX strategy at HSBC.
“The ECB isn’t just fighting a strong euro, it’s fighting a weak dollar – that’s a two-pronged problem,” he said.
Lynch downplayed the likelihood of ECB intervention in FX and reminded that the ECB bank was a “signator” on the G20 statements in early 2013.
In the April 2013 G20 communique, members said, “We will refrain from competitive devaluation and will not target our exchange rates for competitive purposes, and we will resist all forms of protectionism and keep our markets open.”
The G20 April 2014 statement, released last week, had far less FX mention and talked only about achieving “exchange rate flexibility.”
Like many others in the currency market, Lynch eventually looked for the euro to weaken as the U.S. economy picks up steam and U.S. Treasury yields rise faster than eurozone yields.
“That’s clearly not happening yet,” he said.
For the euro to see a larger move lower, the market “will need to be more convinced” that a change in ECB monetary “is likely, and that it is going to be effective,” Lynch said.