ECB stimulus measures likely put a firmer floor in the euro but a sustained rally remains unlikely

ECB stimulus measures likely put a firmer floor in the euro but a sustained rally remains unlikely           

• EUR: Key ECB stimulus measures announced overnight – (1) A 10bp deposit rate cut to -0.5% versus market pricing for a 15bp cut with President Draghi expressing concerns over the negative side effects of negative rates, suggesting the ECB is reluctant to lower interest rates in the remainder of this year; (2) Lower than consensus new asset purchases (QE) of €20bn/month (consensus EUR30 - 45bn), starting November 2019 but open-ended “to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates”; (3) A qualitatively similar QE to QE1 in retaining sovereign debt purchases as its main plank but with no increase to issuer limits, leaves market to ponder where the ECB will source its bonds as the cap has already been hit for some… including Germany. This, along with the issuer uncertainty, appears to limit how “open-ended” the ECB’s QE package will really be. The new QE program also faces widespread opposition – from French, German, Austrian, Estonian and Dutch governors; (4) Tiering of excess reserves to alleviate bank profitability concerns emanating from negative rates; (5) Strengthening forward guidance on interest rates to be stable or lower “until it has seen the inflation outlook robustly converge to a level sufficiently close to, but below, 2% within its projection horizon, and such convergence has been consistently reflected in underlying inflation dynamics”; (6) New staff projections - ECB downgrades inflation outlook (notably a forecast of 1.5% HICP inflation in 2021) but remains optimistic on baseline growth.        

• EUR: Selloff in euro and Bund yield decline short lived - EURUSD’s knee- jerk reaction to the modest rate cut and QE is a one big figure dive to a 1.0927 low (from around 1.1028) while 10Yr German Bund yields decline 7bp to -0.64bp. The moves however are short lived with EURUSD closing the overnight session at 1.1065 and 10Yr Bund yields up at -0.54%. Reasons for the market’s “hawkish” reaction – (1) QE - No discussion on Issuer limit or composition of asset purchases amid widespread opposition to re-starting QE; (2) Draghi de-emphasizing rate cuts while describing fiscal policy as the next big thing; (3) President Trump’s reaction - Draghi notes ECB doesn’t’ target FX but this does not stop Trump from delivering yet another harsh rebuke to the ECB.     

• EUR: Bottom Line – a likely firmer floor sub 1.1000 on EURUSD but a sustained rally remains elusive until (1) a US – China trade resolution; and (2) fiscal stimulus delivered by core Europe to complement the overnight ECB measures.  

Safe havens: Tactically bearish ahead of US – China talks in October        

• JPY, CHF & Gold): US - China trade – An “interim” trade deal? Reports overnight suggest Trump officials have discussed offering a limited trade agreement to China that would delay and even roll back some US tariffs for the first time in exchange for Chinese commitments on intellectual property and agricultural purchases. Trump himself is not ruling out the interim China deal and the news follows reports that China is trying to push an agreement through by suggesting that issues of national security should be left to a future date. China is also reportedly considering US farm imports (soybeans and pork) as a goodwill gesture before talks in October. All this comes as Trump indicates he is postponing imposition of 5% extra tariffs on Chinese goods by two weeks, amid signs that the two sides may be more willing to negotiate as officials prepare to meet in Washington in coming weeks.   

USD: Fed to cut 25bp despite strengthening in US core CPI

• USD: August core CPI hits 0.3% for 3rd consecutive month -  stronger than Citi analyst expectations for 0.18% and YoY reading at 2.39% is the fastest rate of increase since 2008. Citi analysts see the underlying pace of core inflation now running very close to target with transitory weak factors having faded. Elements of CPI now imply a 0.14%MoM increase in core PCE, which would deliver 1.7% YoY inflation (with risk of 1.8%) for the Fed’s preferred measure.                

• USD: The stronger CPI report should do nothing to alter Fed officials' decision to lower rates 25bp next week. But the increasingly-likely return of core PCE inflation to 2% over coming months could make some Fed officials reluctant to reduce rates further. USD outlook  - Our CitiFX Quant analysts’  latest World Exchange Rate Model (WERM) update based on Q2 2019 economic data leaves the USD as the most expensive currency with a nearly 18% trade weighted overvaluation.           

GBP: Sentiment firm on a possible Brexit solution    

• GBP: Reports overnight that UK PM Boris Johnson is considering plans for a regulatory border in the Irish Sea for an all-Ireland zone for checks on livestock and agricultural goods crossing between Northern Ireland (UK) and Republic of Ireland (EU) as part of a deal to remove the need for a Northern Irish backstop. The idea, which does not cover tariffs on goods, has been discussed with his coalition partner (DUP) at which PM Johnson also offers a “Stormont lock” (veto by the Northern Irish Assembly – when it is up and running) to ensure Northern Ireland would be able to veto any future changes to the arrangement. DUP is understood to be receptive to the idea even as it insists there must be no divergence in tariffs between Northern Ireland and the mainland. PM Johnson believes the problem of tariffs can be solved by so-called “alternative arrangements”, including trusted trader schemes and electronic pre-authorization of goods. It also emerges that PM Johnson had ordered feasibility studies on the possibility of a bridge between Scotland and Northern Ireland.

• GBP: The reports dovetail with comments from new EU Trade Commissioner Phil Hogan who claims there is “movement happening on both sides” over the issue of cross-border trade and that Irish PM Leo Varadkar wants to “revisit” the idea of a Northern Ireland-only backstop. Hogan expresses optimism that both EI and UK can build on this new proposal as PM Johnson has made clear he would accept “some level of divergence” with Northern Ireland, the “first time by a British Prime Minister”.        

This is an extract from the Daily Currency Update, dated September 13, 2019. Please approach a Citigold Relationship Manager if you would like more information.