The prevailing market view seems to be that the ECB will cut the main refi and deposit rates and will introduce additional liquidity measures – e.g. suspend the sterilization of SMP – next week, notes CitiFX.
“The view may also be largely in the price by now, given the four-big figure EURUSD selloff and the drop in euro money market rates in recent weeks (Figure 1). This conclusion is confirmed by our positioning gauges which suggest that investors are running extensive EUR-shorts at present,” Citi adds.
“We would argue that the potential introduction of negative deposit rates may have a stronger impact on EUR than currently anticipated by the market,” Citi argues.
How to position?
“In particular, selling EUR against other, higher-yielding currencies by European banks holding excess cash could be the path of least resistance,” Citi answers.
Citi outlines 2 reasons behind this view:
1/ Lending the cash to other banks in the Eurozone could be hampered by insufficient compensation for counterparty risk. In addition, lending to the real economy could be hampered by lackluster demand for loans from non-financial corporates and still growing non-performing loans in the periphery.
2/ Buying peripheral bonds could be less attractive going into the bank stress tests that could penalize excessive exposure to government debt. In addition, buying liquid short-term paper or collateral like Schatz and BTan could be less attractive given their valuation.