Draghi’s Attempt to Talk Down Euro Lost on Traders:
|April 1st, 2014, 09:59 PM||#1 (permalink)|
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Draghi’s Attempt to Talk Down Euro Lost on Traders:
As far as currency traders are concerned, it’s going to take more than words for European Central Bank President Mario Draghi to weaken the euro.
The 18-nation currency has slipped 0.5 percent against a basket of nine developed-market currencies since Draghi said March 13 that the exchange rate is “increasingly relevant in our assessment of price stability.” That compares with a drop of 1.9 percent for the yen and a gain of 0.1 percent for the dollar, according to Bloomberg Correlation-Weighted Indexes.
The ECB, which meets tomorrow, is under pressure to stem a 20-month advance in the euro that has contributed to a slowdown in inflation that’s barely a quarter of its 2 percent target and has weighed on growth. Among the actions Draghi may take are cutting the central bank’s record-low interest rate or stop mopping-up the excess liquidity from its asset-purchase program.
“The time for talk is over and measures must be implemented,” Neil Jones, the London-based head of financial institutional sales at Mizuho Bank Ltd., said in a telephone interview yesterday. “Talk is not going to do it. Verbal intervention is insufficient.”
Euro bears may need to be patient. Policy makers will keep their benchmark rate at a record 0.25 percent, according to all but three of 57 economists in a Bloomberg News survey. One sees a cut tomorrow to 0.1 percent while two call for 0.15 percent.
The euro strengthened 8.1 percent over the past year, snapping four straight annual declines from 2009 through 2012, according to Bloomberg Correlation-Weighted Indexes.
As it did for all of 2013, the euro performed better in the first quarter than analysts in Bloomberg surveys predicted, strengthening 0.2 percent to $1.3769, compared with a median prediction of a 3.2 percent drop to $1.32. In December 2012, they forecast it would finish 2013 weaker at $1.27, which turned out to be 8.2 percent lower than the $1.3743 close on Dec. 31.
Jones sees the currency climbing to $1.40 this year, from $1.3793 yesterday in New York. The median forecast of 88 contributors in a Bloomberg survey is for the euro to finish this year at $1.30.
The euro has been driven by signs that the region’s economic recovery is gathering strength, reinforcing demand for assets denominated in the currency that started when Draghi pledged in July 2012 to prevent it from splintering.
While the currency’s strength is a tribute to Draghi’s success in driving out speculation on its demise at the height of Europe’s sovereign-debt crisis, it risks curbing an economic recovery amid almost record joblessness.
Purchasing-manager indexes released last week showed factory and services activity in the first quarter was the strongest in almost three years, and confidence in the region was the highest since 2011. In the euro-area, the jobless rate was at 11.9 percent in February, while in Italy it climbed to 13 percent, underscoring the dilemma facing ECB officials.
“The PMIs show the euro-zone is not contracting -- it’s a stagnation, but some are calling it positive growth,” Marc Chandler, the global head of currency strategy in New York at Brown Brothers Harriman & Co., said in a telephone interview on March 31. “That all will buy the ECB time because the next step the ECB may have to take is more drastic, such as a deposit-rate cut to negative yields. That’s a nuclear option because the ramifications are hard to know.”
Draghi’s March 13 comments were the latest example of ECB officials becoming more vocal about the currency’s strength. He said March 6 that the exchange rate had cut 0.4 percentage point off inflation. Governing Council member Christian Noyer was more forthright four days later, saying a stronger euro creates unwarranted pressure in the economy.
Traders are betting that the euro’s resilience will endure, as shown by measures in the derivatives market ranging from future volatility implied by option prices to the cost of insuring against a drop in the single currency.
The 25-delta one-year risk reversal rate was at a 1.02 percentage-point premium for euro puts, which grant the right to sell the currency, over calls, the least since February 2013 based on closing prices. That’s down from the 2014 high of a 1.39 percentage point premium on Jan. 2.
Implied volatility on three-month options for the euro-dollar pair is at 6.5 percent, down from a peak last year of 9.5 percent in February, signaling traders see less chance of big swings in the euro.
Hedge funds’ and other large speculators’ bets on the euro are now at 39,634 contracts in favor of appreciation of the euro, according to data from the Washington-based Commodity Futures Trading Commission as of March 25. That compares with a net-short position as recently as mid-February.
Another setback for euro bears came this week, when U.S. Federal Reserve Chair Janet Yellen said on March 31 that “considerable slack” in U.S. labor markets showed that the central bank’s accommodative policies will be needed for “some time.”
Yields on U.S. fixed-income assets became more attractive to investors after traders began to price in a rate increase by the Fed in the middle of next year. Two-year Treasuries yielded about 0.3 percentage point more than German bunds last month, up from 0.07 percentage point in December.
“We are not going to see higher rates in the U.S., for as much as people talk about,” Axel Merk, president and founder of Merk Investments LLC in Palo Alto, California, said in a March 31 telephone interview, predicting that the euro will climb to $1.50. “So the U.S. isn’t quite as great a place to invest in and Europe isn’t quite as bad a place to invest in.”
A report this week showed euro-area consumer prices rose an annual 0.5 percent in March, compared with the ECB’s target of just below 2 percent, raising the specter of a Japan-style era of deflation that discourages investment and spending. Prospects of ECB action faded after Governing Council member Jens Weidmann, who’s also head of Germany’s Bundesbank, said March 29 that officials should only react to “second-round effects” of slowing inflation, which aren’t evident currently.
“There isn’t enough confidence that the ECB will respond to the disinflation we’ve seen so far,” Henrik Gullberg, a London-based currency strategist at Deutsche Bank AG, said in a telephone interview on March 31. Traders “need the ECB to respond to disinflation” before selling the currency and using the proceeds to invest in higher-yielding assets, he said.
Draghi?s Attempt to Talk Down Euro Lost on Traders: Currencies - Bloomberg