EURUSD has been gradually unwinding it’s overvalued position upon the expectation that the ECB will attempt to ‘talk down’ the Euro. Despite a track record of doing so within the central bank, telling currency markets what to do is no simple thing. The consensus forecast for today’s monetary policy decision is for no change in policy. Once again, those looking for clues on the Euro’s path will have to look away from the main headlines and instead assess President Lagarde’s rhetoric particularly surrounding exchange rates. If she doesn’t mention them, expect short term Euro strength, but watch out, you can bet the first question at the press conference will be on EURUSD.
The ECB has played guardian of the gate before. Notable performances include Mario Draghi in 2014, Super Mario again in 2018, and Jean-Claude Trichet in the Euro’s toddler days of 2004. Each of these attempts amongst others have successfully put a lid on Euro strength and encouraged weaker rates of exchange when selling Euros. With EURUSD still looking towards 1.20, the market is waiting to see if the ECB has had enough.
So where did all of this come from? The Euro is only at 2 year highs versus the Dollar and there’s quite a lot else afoot to worry about. Well, the last time the Euro exceeded its level today by a handful of cents it was sent packing by the incumbent President of the ECB, Mario Draghi. On top of that the appreciation of the Euro in Dollar terms since the beginning of the pandemic alone has been in excess of 12.5%. This rally has put considerable strain on Eurozone exporters and resulted in these products being less competitively priced in international trade. At a time when global commerce is under threat from the pandemic, the Eurozone will be particularly wary of allowing an overvalued currency to stand in the way of its economic recovery.
The situation prompted prominent ECB member Philip Lane to say that the Euro’s exchange rate does matter. His words were a nod to markets and perhaps an admonition of bank intervention if the exchange rate continues to drive higher and into the 1.20s. The rejection of prices above 1.20 following these comments at the beginning of September has left the Euro in limbo, waiting for today’s monetary policy decision. Short-term options market volatility is at its highest level since March as those with an exposure to the Euro are increasingly willing to pay a premium not to be on the wrong side of Lagarde’s words. The open market interest moving into this decision will inevitably bring with it market volatility. The decision itself is released at 11:45 with the potentially more important press conference following 45 minutes later.
Discussion and Analysis by Charles Porter