The euro is diving today after Spanish PMI showed a turn towards deflation, prompting hopes that the ECB might engage in more aggressive easing next week.
To those betting against the Euro, SocGen’s Kit Juckes offers a note of worry:
I would love to believe, a) that the ECB is close to further easing and b) that this will weaken the euro significantly. But while my heart screams ‘yes’ my head shakes and whispers ‘no’. On QE, I think the trigger is deflation not lower inflation, and I worry the current bout of ECB chatter is just that. But let’s say for the sake of argument they act, I will be wary of a repeat of the response we got from LTRO. That is to say, it takes rates down, and boosts appetite for European equities and bonds, especially peripherals and corporates. But here are the two problems with that: firstly, LTRO saw the euro fall on the announcement and then rally sharply as risk aversion faded and peripheral bonds rallied. QE may do the same. And secondly, QE can boost bonds but yields are low and spreads are tight. Help equities but they are already doing OK, and get rates down but if US QE didn’t get 2yr dollar swaps below 35bp, would the ECB achieve more? Fed QE has already boosted asset prices and anchored rates globally. The ECB action would help but the returns are diminishing. So Mr Draghi, please go for QE, please change market psychology, but I am more likely to buy Btans vs 5yr Notes, or equities, or bank credit, than go nuts about a weaker euro if it happens. EUR/USD bears need to see US 2yr rates going upwards to really get any joy.