ECB is behind the curve on global risks; re-centering our EUR & JPY rates forecasts lower

The EUR is more vulnerable to downside global risks. Our EUR and JPY rates forecasts have been nudged lower.
Eugene Leow, Philip Wee18 Jun 2019
    Photo credit: AFP Photo

    FX: ECB is behind the curve on global risks

    The USD Index (DXY) is not immune to global risks but its major component, the euro, is considered more vulnerable to downside global risks. The European Central Bank’s annual symposium in Sintra was a follow-through from its governing council meeting on June 6 when it pushed back rate hike intentions. Although encouraged that recent EU data have stabilized, the ECB is not blind to adverse risks implied by record low negative EU bond yields.

    If its cautiously optimistic outlook is unstitched by another escalation in global trade tensions and a disorderly Brexit, the ECB will consider lowering rates by tiering the deposit rate as a contingency plan. Looking ahead, there is certainly less room for complacency. The Eurozone Sentix Investor Confidence fell to -3.3 in June, back into negative territory after a one-off spike in May. Another retreat in today’s ZEW survey, which has already returned into negative territory in May, would reinforce the view that the ECB is behind the curve. Our view remains for the euro to break below 1.10 in the coming months.

    Rates: Re-centring our EUR and JPY rates forecasts   

    We have re-centred our EUR and JPY rates forecasts lower. Most of this reflect the disappointing economic numbers across the Eurozone and Japan that would likely necessitate an extended period of loose monetary policy. Forward guidance from the European Central Bank (ECB) and the Bank of Japan (BOJ) will likely be dovish. Room for the ECB to embark on even more aggressive easing is limited and while data has been weak, we do not think that the authority has the appetite to cut the deposit rate (already at -0.4%) further or embark on another round of quantitative easing (given that TLTRO 3 has been announced). The only reasonable tool left at the ECB’s disposal would be to guarantee that short-term rates can stay low for an extended period, depressing term premium in the process. Notably, 10Y German yields have pushed to an all-time low (-0.25%) as investors take advantage of the still-steep govvie curve.

    Similar arguments can be made for JPY rates. While the BOJ has allowed 10Y yields to hover within the -0.2 to 0.2% range, yields have been stuck below -0.1%. We think that the BOJ may be reluctant to allow yields to fall deeper into negative territory given unintended consequences on the financial system. In any case, the pace of bond buying has slowed significantly over the past few months. Our EUR and JPY rates forecasts reflect the lower-for-longer narrative amid a challenging global backdrop. However, with USD, EUR and JPY rates already at depressed levels, we are reluctant to chase yields lower. Instead, our forecasts are for a modest rise in longer-term G3 rates (some steepening to take place) over the coming quarters.     

    Eugene Leow

    Rates Strategist - G3 & Asia

    Philip Wee

    FX Strategist - G3 & Asia

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