The euro rallied up to the 1.0600 level on the view the ECB will raise rates by 1.5% by year-end but the Fed will ease back on hikes but the reality is – the Fed will continue aggressive hiking and the ECB can’t hike as much as the market expects our views on why below…
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The ECB’s Big Problem Spiking Bond Yields and Fragmentation
They need to raise rates to tame inflation but can’t as bond yields in the weaker nations have spiked higher so what can the ECB do? “Fragmentation is a threat inherent in the eurozone structure. We will consider anti-fragmentation tool at July policy meeting.” (ECB President Christine Lagarde) We have seen Italian yields spike higher.
Assuming the ECB actually has as much flexibility in the PEPP reinvestments as it claims, and if it was willing to use all that flexibility and circulate the proceeds from all the maturing bonds in the PEPP portfolio to Italy, for example, then already that would make a difference. The ECB has a lot of means at its disposal, but since none of them are uncontroversial, there may be more unwillingness for their full use. (NORDEA)
Let’s see what the fragmentation tool is – our view is it will just be printing money to hold yields down the idea the ECB will raise rates by 1.5% in our view can’t happen.
Europes Energy Crisis
Even more bad news from the zone is the energy crisis is about to worsen. German Foreign Minister Annalena Baerbock said that the country was in the midst of hybrid war as the Russian conflict in Ukraine exacerbates the European energy crisis. We are faced now in Germany with the question now that if there is no gas coming through Nord Stream 1 … we have to decide which institution may be cut off the grid.
Russia will as we get to winter probably cut the gas off to Europe it’s already going into recession and the above if it happens will make the recession deeper. Robin Brooks Notes: “Our underlying assumption has always been this is where Europe ends up: complete shutdown and recession.” Gas supply chart below:
ECB Rate Rises won’t Match Market Expectations
We have a central bank that has high inflation but can’t raise rates due to the poorer nations’ cant take higher borrowing costs the outlook for the zone is dire we expect to see a recession and even could see a weaker country hit a liquidity problem. The market is to relaxed about the ECB being able to solve the fragmentation problem and raise rates to 1.5% by year-end.
USD Bullish Fundamentals v EUR
On the other side of the pair the USD has very bullish fundamentals: This week Federal Reserve Chair Jerome Powell reiterated Fed’s commitment to do whatever it takes to control high inflation and said the bigger risk is to fail to restore price stability.
Powell also noted that the US economy is in a good shape and well-positioned to withstand tighter monetary policy and that he hopes growth will remain positive, although there is a risk it will slow more than needed. He also confirmed the Fed is raising rates expeditiously and aims to move into restrictive territory fairly quickly…
There is a clock running here, where we have inflation running now for more than a year,・he said. That would be bad risk management to just assume those longer-term inflation expectations would remain anchored indefinitely in the face of persistently high inflation. So we are not doing that. (Fed Chairman Powell)
Nothing new in the above the message has been the same for months but the market was looking for the Fed to back down due to the chances of a slow up in the US economy or even a recession – there will be no slow up.
Technical Analysis
The rally to 1.0600 failed and this is no major resistance with 1.0500 as nearby resistance. A sell-off to new daily lows is expected to follow through down to monthly support at 1.000 then 0.9600.
