EUR trader - The ECB expected to bring out the big guns next week

As markets evolve, we are seeing strong activity in the EUR, certainly on the FX crosses, where the dynamics from a relative rate setting are well worth being across. Taking a broad approach, we can look at market pricing and the policy expectations across the suite of G10 FX central banks and believe it will be a very lively September indeed.

As it stands, the market fully prices a 75bp hike from the Fed. There is an 80% chance priced of a 75bp hike from both the ECB and the BoC. In the UK, the market prices a 64% chance of a 75bp hike from the BoE – The RBA and RBNZ are fully expected to hike by 50bp in their respective meetings.

It’s the ECB’s potential action that is getting the most attention today, with traders starting to look ahead to its meeting on the 8 Sept. After we saw headline inflation rising to 9.1% and core inflation at 4.3% YoY, the feeling is the ECB need to step-up the front-loading of rate hikes. While a 75bp hike is now largely expected next week, we can look ahead and see the market split between a 50bp or 75bp hike in the October ECB meeting, with the ECB’s deposit rate setting expected to peak at 2.4% by July 2023.

This is having a negative effect on European bonds, and we are seeing bond yields rise – adjust for expected inflation and German ‘real’ rates are moving higher relative to G10 FX nations, even the US, and this is promoting a bid in the EUR - it’s certainly making funds with lumpy short EUR positions very nervous.

We can argue that hiking so aggressively into a slowing economy just accelerates recession risk – so from a relative growth perspective, this makes the EUR wholly unattractive – certainly, when we look at any of the European equity indices the trend is most definitely your friend.

We continue to watch EU nat gas and German electricity prices and while we have seen both in decline in the last few days, this could change if the Nord Stream 1 pipeline fails to return to prior flow levels after maintenance concludes (tomorrow). While a resumption of flow seems likely, one suspects that would bring out EUR sellers if that isn’t the case.

EURJPY daily

Still, many of the issues plaguing Europe are true of the UK, in fact, EURGBP is on a flyer and while momentum suggests this pair can perhaps stretch into 0.8700, it feels like the risk is we initially see a slight retracement back to 0.8600, before the buyers step back in. EURJPY has also rallied close to 400 pips in this recent run and is a juggernaut as relative rate settings manifest – I like this into Y142 over the medium-term, but the risk is right now that we pull back to 139.00/138.50, before a new leg up.

EURSEK and EURNOK are less traded by clients, but again have had solid runs and look well support into weakness.

We look forward to a central bank blitz in September and some pretty clear statements of intent – this month has the potential to be the tipping point, where higher rates really squeeze demand across a broad set of economics. For now, the market is reacting to the repricing of ECB policy expectations, but whether this continues on a sustained basis given the ongoing economic challenges is another thing.