Australian dollar cork in Fed, ECB, PBOC storm

The past week has seen a further consolidation within established ranges in the G10 complex, with the best relative performances coming through the EM space among EMEA currencies, in particular the CE3 which are benefiting from local rates re-pricing in the face of strong growth and rising inflation risks. Of key importance remains the face-off between different central banks when it comes to signaling to markets a lack of appetite for monetary tightening, CE3 having joined Canada in being notable exceptions to this rule. On the US side, monetary policy doves, and investors who are extremely long risky assets, continue to hope that even talking about tapering asset purchases is seemingly“cancelled” at the Fed for now. As last week’s release of the minutes of April’s FOMC showed, from time to time Fed officials do raise the idea that at some point in coming months US data flow could finally justify that discussion finally beginning, the latest example being Fed governor Clarida yesterday. But so long as the Fed remains purposefully fuzzy about what exactly would need tobe seen to change tack, let alone when, the market seems likely to fade the idea that this tapering discussion will be happening any time before late summer at the very earliest. Together with the ongoing sharp rise in apparent liquidity in US money markets we discussed last week (link), this creates a backdrop that keeps the USD on the back foot, especially if other regions and countries are either posting strong recoveries from the pandemic, or reacting to higher inflations risks, or both. In essence, monetary policy divergences have been working against the greenback, at both short and long ends of yield curves.

On the other side of the coin, the ECB continues to push back against the idea that it is close to a serious tapering conversation of its own with respect to its PEPP purchases. Yesterday Bank of France chief Villeroy said that the ECB has “ample time to judge and decide, well beyond our June meeting”, adding that “any hypothesis of a reduction of purchases partly for the 3rd quarter or the following quarters is purely speculative”. He was also keen to point out that other tools such as APP purchases or even deposit rate cuts can yet be employed more forcefully to make up for any decline in PEPP purchases down the line. In our view, Villeroy’s specificity is not an accident. Rather, he is likely aiming at tamping down market expectations that the 10 Jun ECB meeting could lead to PEPP tapering starting as soon as July. Similarly, ECB chief Lagarde’s comments last week pointing to a need to monitor recent euro are a yield increases is a reminder to markets that levels do matter, even if the euro area growth outlook is now brighter. As Figure 2 and Figure 3 show, the market has become a touch excited about the possibility of the ECB meeting leading to a EUR-bullish outcome, with implied volatility bid for the meeting and short-dated risk reversals well bid for EUR calls (despite the latter being the case for longer-dated tenors).