Euro Burdened By Prospect Of ECB Action In March – Is It A Real Threat?

With equity markets turning around sharply by the end of the week – thereby removing a key source of strength for the Euro thus far in 2016 – the Euro fell broadly across the board. EUR/JPY’s performance was revealing in this regard, having gained +0.58%, only one of the two major EUR-crosses to post gains on the week (EUR/CHF was the other, up +0.34%). Indeed, with the European Central Bank’s policy meeting on Thursday being the source of optimism for markets globally, it’s not much of a surprise that the threat of policy action in March – particularly at a time when the news cycle is so negative and market participants are starved of monetary policy stimulus from central banks in advanced economies – sunk the Euro more broadly elsewhere.

Fundamental Forecast for EUR/USD: Neutral

The Euro’s reaction across the board is telling: sentiment is extremely fragile and prone to exacerbate price swings across asset classes. However, it wasn’t nearly as significant in terms of the magnitude of the decline relative to what happened after the ECB’s meeting in October 2015. Thus, there is one question which we seek to answer: do markets take the ECB’s hint for more stimulus in March as a credible threat?

At first blush, “yes” may seem like the logical answer. After all, the Euro posted its first losing week across the board for the first time all year, and global equity markets stabilized – if violently – after several days of tumultuous trading. Of course, then, with so much optimism having sprung henceforth, traders must feel that the ECB’s threat of upgrading its stimulus outlets is legitimate.

Yet when we try to answer this question from the ECB’s perspective, the answer may in fact be “no.” As we’ve touched on in recent weeks, the ECB, like so many other central banks in advanced economies, has fallen into the predictable pattern of only altering policy when it has new economic forecasts in hand. This of course is a symptom of the global shift to more transparency in central banks’ activities, which in turn may be having a chilling effect on these institutions’ abilities to change policies quickly. By changing policy without a change in economic forecasts, central banks would otherwise expose markets to greater uncertainty as market participants inevitably ask themselves, ‘what do the central banks know that we don’t?’