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Draghi Cedes Euro Control to Yellen on Fed Rate Wagers
Started:July 22nd, 2014 (07:51 PM) by kbit Views / Replies:119 / 0
Last Reply:July 22nd, 2014 (07:51 PM) Attachments:0

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Draghi Cedes Euro Control to Yellen on Fed Rate Wagers

Old July 22nd, 2014, 07:51 PM   #1 (permalink)
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Draghi Cedes Euro Control to Yellen on Fed Rate Wagers

Mario Draghi’s ambitions to weaken the euro are at the mercy of Federal Reserve Chair Janet Yellen.

The U.S. central bank chief sent the euro sliding below $1.35 last week for the first time since February when she said U.S. interest rates may rise sooner than investors expect. Her European Central Bank peer is having less impact: Draghi’s unprecedented decision to drop a key interest rate to below zero last month pushed the shared currency up 0.2 percent before Yellen’s speech. The euro is also losing its link with the continent’s bond market, as its correlation to the yield spreads of Italy, Spain and Portugal approaches zero.

Dealers in euro-dollar, the world’s most-traded currency pair, say they’re increasingly influenced by the U.S. because they’ve assimilated the interest-rate cuts Draghi unveiled and concluded he has no further surprises in store. The prospect of a Fed rate boost is also deemed more important than the conflict in the Gaza Strip and international anger over the downing of a Malaysian airliner last week in Ukraine.

“The market is completely ignoring the European news,” Brad Bechtel, the managing director of Faros Trading LLC in Stamford, Connecticut, said yesterday in a phone interview. “So when the dollar moves, it’ll move, but anything European-specific is not enough. Euro-dollar is also seemingly ignoring all geopolitical noises, whether it’s Russia and Ukraine or Gaza.”
Breaking Link

Yellen’s testimony to lawmakers in Washington July 15-16 hastened the breakdown in the link between the euro and bonds, after appetite for European debt helped push the shared currency up by 4.2 percent in 2013, its biggest advance in six years. The U.S. central bank has maintained its federal funds rate target in a record-low zero-to-0.25 percent range since December 2008.

“Euro-dollar is now moving as a function of the Fed,” Sebastien Galy, a senior currency strategist at Societe Generale SA in New York, said yesterday in a phone interview. “For the few years since 2010, euro-dollar moved because people were seeking to sell or buy a European risk premium in a very mechanical fashion” before that correlation collapsed, he said.

A waning ability to influence the euro will prove frustrating for Draghi, who said July 14 that the relative strength of the 18-nation currency poses a risk to the economy. The exchange rate rose 0.1 percent that day.
Short Lived

At its June policy meeting, the ECB cut its main refinancing rate to a record 0.15 percent and became the first major central bank to take a key interest rate below zero. It also offered banks funds that they can keep through 2018 at cheap rates. Reducing borrowing costs and increasing the money supply tend to weaken a currency by making it less profitable for an investor to hold.

The measures had little effect, with the euro closing at $1.3619 on July 14, compared with $1.3599 the day before the June meeting. The shared currency fell to $1.3491 on July 18, and was at $1.3480 as of 11:07 a.m. in London today.

The euro’s 14-day correlation to peripheral euro-region bond spreads dropped to 0.14 on July 14 and was at 0.22 today, down from 0.71 on July 3, data compiled by Bloomberg show. That’s near a high of 0.75 on Jan. 21, which represented the closest relationship with the 18-nation currency since September 2000. A reading of 1 would mean they’re moving in lockstep while minus 1 signals the opposite.
‘Serious Concern’

The measure averages the 10-year bond yields of Italy, Spain and Portugal and calculates their spread over benchmark German bunds.

Even before the stimulus program, Draghi was fighting a war of words against the currency’s strength, saying at the ECB meeting in May that an appreciating euro “in the context of low inflation is cause for serious concern.”

He said on March 13 the exchange rate is “increasingly relevant in our assessment of price stability.” Consumer prices rose 0.5 percent in the year through June, compared with the ECB’s target of just under 2 percent.

While the single currency’s links with European factors have decoupled, they’ll come back into play in coming months as the euro-region economy slows, said Adnan Akant of Fischer Francis Trees & Watts Inc., which oversees more than $50 billion.
Market Complacency

“The U.S. side of the equation is working now as the market has put Europe’s crisis on hold, but it’s not going to last too long,” Akant, the New York-based chief investment officer for foreign-exchange at Fischer Francis, said in an interview on July 16. “Between now and September, something will come along to shake the complacency. The market will suddenly think, now it’s time to sell the euro as the economic acceleration has peaked.”

One such event that failed to roil the euro was the July 18 request for creditor protection by a company tied to Portuguese lender Banco Espirito Santo SA, after it was unable to make payments on its debt.

After Draghi stemmed the sovereign-debt crisis in July 2012 by pledging to do “whatever it takes” to save the euro, there was some speculation he’d step in to limit any contagion caused by the company’s failure.

The euro also shrugged off the impact of two weeks of violence between Palestine and Israel in Hamas-controlled Gaza, and speculation the shooting down of Malaysian Airlines flight MH17, apparently by Russia-backed Ukraine militants, will lead to increased sanctions against Moscow.
‘Barely Budging’

The currency “is barely budging” as a result of the Ukraine news, Douglas Borthwick, the head of foreign exchange at New York brokerage Chapdelaine & Co., said yesterday by phone. “We’ve never seen this little volatility.”

Three-month implied euro-dollar volatility rose to 5.26 percent today, still just a half-percentage point from the record low of 4.75 percent on July 15.

Now that the euro has breached the $1.35 barrier, it’s likely to move closer to $1.30, according to Steven Englander, global head of Group of 10 currency strategy at Citigroup Inc. in New York.

The rate is being driven primarily by forecasts for higher U.S. borrowing costs, which are buoying the dollar side of the trade, Englander, whose company is the world’s biggest foreign-exchange dealer, said in a Bloomberg Radio interview on July 18.

Draghi is “a brilliant maestro in terms of how he’s been able to direct the euro -- two years ago, when the euro was falling out of bed, he brought out the big bazooka,” Paresh Upadhyaya, the Boston-based director of currency strategy at Pioneer Investment Management Inc., which oversees $248 billion, said in an interview yesterday. “But now it’s the U.S. leg of it that’s really moving the euro.”

Draghi Cedes Euro Control to Yellen on Fed Rate Wagers - Bloomberg

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