EUR Shorts Want Action Not Talk From ECB

The status quo in the Ukraine was never going to hold, something had to give and the match was lit over the weekend. As violence spread to more towns across the country, the uptick of skirmishes between local law enforcement and pro-Russian separatist forces have now taken lives, further magnifying tensions in the global financial markets.

This fresh escalation of tension has added to the pressures of last week’s equity technology selloff. European bourses are starting this holiday week on the back foot, especially Germany’s DAX index — it’s particularly sensitive to events in the Ukraine due to Germany’s and Russia’s close trade ties. Investors should expect any Ukrainian tension to play a major part in containing “risk-taking” this week. Neither will help liquidity nor prices in the run-up to the Easter holiday weekend. Already this morning the market has seen the commodities sector benefiting, with the “yellow metal” and “black gold” in-demand from a flight to safety assets (gold up +0.8% to $1,327.20 and Brent $108.08 +0.7%, respectively). However, overall event risk continues to remain relatively contained, just look at the movement in USD/yen. Usually, when asset classes come under stress, historically it is the yen that gets bought most often. Currently, USD/JPY is relatively unchanged against the “mighty” buck (¥101.67).

European Talk-Down Begins

In forex, it’s the EUR that is hogging all the headlines, especially after the European Central Bank (ECB) began stepping up its verbal intervention of the EUR over the weekend. So far this morning, ECB President Mario Draghi’s dovish comments are fueling modest gains in the Euribor market, and a modest loss for the 18-member single currency. Investors remain unlikely to sell the common currency aggressively unless the ECB backs up rhetoric with action – euro policy dealers have yet to declare quantitative easing as imminent. The ECB’s go-to tool is rhetoric, with all members “talking the talk.” ECB governing council member Christian Noyer has reiterated the council’s view that a strong EUR “trims inflation rate by half-a-point.”

The market does understand that a weaker common currency is desirable but easier to talk about than orchestrate. At this stage, investors prefer to see action rather than words. This will make it more difficult for euro policymakers to talk down their own currency. There are only so many times that investors can react listening to the same message. Euro policymakers continue to reiterate there is no danger of deflation, but they believe further EUR strengthening could have negative effects on the economy. The stronger talk is beginning to fall on deaf ears. Since the weekend, it has only been able to buy a modest decline for the EUR. In the big picture, the ECB is running out of “puff” and has probably done all it can with “open and cry” communications. It’s very unlikely that the single currency will fall much further on rhetoric alone – the market requires real action in a show of good faith. Perhaps asset purchases (namely, quantitative easing) may be the appropriate tool to fight low inflation, but it remains contingent on outcomes.

ECB on the Cusp of Easing

From a technical perspective the single currency has seen new intraday lows just ahead of the handover stateside (€1.3806). Even February’s eurozone industrial data rose slightly (+0.2%, month-over-month, and +1.7%, year-over-year), although output in many of the currency area’s troubled southern peripheries declined.

The rise in output should reassure the ECB that it can expect modest growth; however, signs of weaker domestic consumer demand will continue to have a direct negative impact on European inflation. Obviously, with domestic demand waning, European goods and services industries will be relying more on the value of the EUR to boost competitiveness on the global markets. In the end, policymakers must get the EUR down – it’s all in the timing. Single-currency sellers are touted on top between €1.3835-55. Through here expect some intraday ‘short’ buyback panic. The techies’ short-term goal would be to see the well-protected €1.3800 handle breached, opening the way for the momentum trades to focus on the next support €1.3765-70 area.

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