- Consensus sees ECB as positive catalyst, expects some hint of monetary tightening
- Even as Eurozone growth deteriorates, ECB likely to keep guidance unchanged
- As speculator net long positions near all-time highs, "long euro" trade looks risky
Earlier today, we downgraded our euro outlook to neutral in the medium-term, and bearish in the short-term. As the euro runs out of momentum, the trend is now neutral based on quantitative factors such as price, trading volumes and volatility. While forward-looking economic indicators continue to suggest an ongoing expansion, growth appears to be slowing in rate-of-change terms. This is why our previous commentary on the euro argued that monetary policy expectations are now the sole driver behind the currency.
Beyond weaker growth outlook, guidance most likely to remain unchanged
As bulls run out of arguments to buy the euro, the stakes for upcoming communications from the ECB are very high. While most commentators still see the ECB as a positive catalyst, we argue that the Bank will struggle to meet high expectations in the face of clearly deteriorating economic data. In recent weeks, Eurozone equities and the euro have sold off, while bond yields are trading lower (in spite of rising crude oil prices and accelerating inflation). In other words, the market isn’t buying the ECB story.
Given the ECB’s dilemma (rising expectations versus weakening data), we argue that Draghi is most likely to try and buy more time. As a result, we think the ECB will try to make this week’s meeting into a non-event by shying away from any hints regarding the future of its asset buying program. Beyond an expected acknowledgement that the growth outlook is slowing, the Bank is not likely to make any significant changes to its forward guidance. Based on the ECB’s prior press conference, expect to see similar language (underlines added for emphasis):
- Asset purchases: Regarding non-standard monetary policy measures, we confirm that our net asset purchases, at the current monthly pace of €30 billion, are intended to run until the end of September 2018, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim.
- Inflation: This outlook for growth confirms our confidence that inflation will converge towards our inflation aim of below, but close to, 2% over the medium term. At the same time, measures of underlying inflation remain subdued and have yet to show convincing signs of a sustained upward trend.
- Risks: The risks surrounding the euro area growth outlook are assessed as broadly balanced. On the one hand, the prevailing positive cyclical momentum could lead to stronger growth in the near term. On the other hand, downside risks continue to relate primarily to global factors, including rising protectionism and developments in foreign exchange and other financial markets.
While growth has clearly slowed since the previous meeting, Draghi recently communicated that “that [while] the growth cycle may have peaked…growth momentum is expected to continue.” A recent Reuters report, based on sources close to the ECB, also suggested that the recent slowdown is unlikely to sway the Bank’s thinking. According to one source: “We’ve been growing above potential so it’s natural for growth to slow over time.”
“Long euro” remains a consensus idea in the investor community
As we have warned in recent history, long euro positions are crowded looking at speculator net positions on US futures and options exchanges. This is illustrated below for reference:
Euro net long positions just below all-time highs
As can be seen above, the number of net long positions in euro futures and options contracts (+144,819) is currently near all-time highs (slightly smaller than the previous all-time high from late January 2018). In typical fashion, speculators only had fairly moderate long positions in the euro when it made its biggest gains last year. Today, speculators continue to chase an aging (if not extinct) trend.
While sentiment alone is not a good reason to short the euro, extended positioning significantly raises the risk of a big pullback. Additional risks include a neutral trend (based on quantitative factors), decelerating economic growth, and the risk of limited forward guidance from the ECB.
Back when the euro enjoyed a bullish trend, unchanged guidance from the ECB may have been a positive result for the currency. Today, this is more likely to have a negative impact on the currency given heightened expectations.