The greenback ended last Thursday off to wheel as the ECB announced the end of its quantitative easing program in a dovish manner.
As broadly anticipated, the European Central Bank will maintain its €15bn monthly bonds purchase until December 2018. However, contrary to what market participants expected, the ECB won’t raise rates simultaneously but would rather wait until at least the end of summer 2019.
In addition, the central bank has revised its growth forecast to the downside to 2.1% in 2018 compared to 2.4% in March; but inflation forecast has been revised to the upside, from 0.4% to 0.7%. Nevertheless, it wasn’t enough to prevent a massive euro sell-off, which turn ultimately into a broad based USD rally. The FX market stabilised on Friday though.
The demand for German bunds increased sharply yesterday, which sent yields lower. The 2-Year and 10-Year yields gave up 5bps and 12bps and stabilised around -0.63% and 0.39%, respectively. Italian bonds moved in a similar fashion even though the yields’ reaction was less acute. The uncertainty generated by the new Italian government has taken a secondary role as investors anticipate the government will not create as much trouble as initially anticipated.
Overall, nothing much has changed in the monetary policy landscape. The Federal Reserve continues to signal four rate hikes for 2018 and keeps open the option of increasing rates only one more time should the economic data justifies it.
Across the Atlantic, the European Central Bank is taking its time. Even though Draghi disappointed markets by not signalling a rate tightening immediately following the end of QE, we believe that this decision is in line with what was done by the Fed a few years earlier.
On the geopolitical side, the story is much different as Donald Trump carried out his threats of slapping tariffs on Chinese imports. China already announced it would retaliate accordingly. The Trump administration is also hitting the European Union with steel and aluminium tariffs. Against such a backdrop, it is difficult to know how the FX market will react in the longer term. Nevertheless, Trump is acting like a lone wolf by bringing to an end trade peace on its own. This could translate into renewed pressure on the USD; especially should the countries hit by the tariffs decide to retaliate in a coordinated manner.
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