FX Daily: Diminishing marginal return on verbal interventions

USD benefits from the ongoing equity market correction (partly caused by disappointing earnings) but as long as this is just a correction within a medium-term trend of an ongoing recovery (our base case), the impact on USD should not be long-lasting.

Indeed, the cautious message from the Fed yesterday points to a continuation of the loose monetary policy (and toning down expectations of a policy reversal in the coming quarters) suggests deeply negative US real rates are here to stay.

Assuming the global economy starts recovering in Q2 after the tough winter months, this should facilitate further USD decline.

ECB continues its fight against the strong euro, with ECB officials commenting that the market is underestimating the odds of rate cuts. Still, we don’t expect the recent verbal interventions to do much damage to the euro as (a) the market is already pricing c.70% probability of a 10basis point rate cut within a year, and (b) there is not much else the ECB can do beyond the already partially priced-in rate cut.

On the latter, QE purchases are already large (after the ECB increase in PEPP in December), while ECB FX interventions are unlikely in our view (we don’t see the recent fashion of FX reserve built up among smaller central banks to be a valid option for the ECB).

With the trade weighed euro below its six-month average and EUR/USD around 1.21, one may question the timing of the ECB verbal intervention and why the ECB didn't keep its powder dry for more pressing times, particularly as we are likely to see diminishing marginal impact of every next verbal intervention as long as it is not followed by actual measures and valid threats (such as rate cuts) get (partly) priced in.

Indeed, and despite the recent ECB comments, EUR/USD held up fairly well and is still around the 1.2100 level. The ECB comments may delay, but not derail EUR/USD strength this year as USD stays soft throughout 2021.

The political jitters between the EU, AstraZeneca and the UK don’t appear to have a negative impact on GBP.

We look for further EUR/GBP decline over 2021 as the UK vaccination advantage (and its likely earlier recovery) and GBP undervaluation vs EUR are to benefit sterling.

High beta low liquid NOK has been leading G10 currencies declines over the past days.

With the NOK positioning adjustment under way (after its strong gains in early Jan), the next key level to watch is EUR/NOK 10.6930.

We expect this to hold as (a) the correction in risk assets should not be long lasting (b) NB has been the most hike prone central bank in the G10 FX space