As the ECB delivers its well-telegraphed 25bp hike, we doubt it will signal enough commitment to further tightening to validate the market’s aggressively hawkish pricing. That leaves exposed to downside risks, particularly as the may find additional support after yesterday’s smaller-than-expected Treasury buyback announcement
USD: Some Bessent Risk Premium Leaving the US Dollar?
Poor price action for the dollar persisted for most of yesterday. Then came the US Treasury announcement that it would buy back $6bn in long-term bonds, triple the amount announced in August. The bond market’s negative reaction signals that expectations were clearly of a higher figure – somewhere around $10bn had been rumoured. However, that prompted a dollar rebound, as some risk premium linked to outsized Treasury intervention was unwound.
The currency market is unlikely to shelve the debasement narrative just yet. But yesterday’s announcement could help create a better environment for the dollar, potentially allowing it to respond more efficiently to external drivers such as higher oil prices and weaker equities, both USD positives.
Today, focus will be on US inflation for August, which should have a higher-than-usual market impact ahead of tomorrow’s and next week’s FOMC. Consensus is for 0.4% MoM headline PPI, and 0.3% for . We feel these are figures that can – if anything – slightly reinforce market conviction on a September : pricing is currently 16bp.
We continue to see upside risks for the dollar. If front-end USD rates remain around current levels and global sentiment stays fragile, we cannot see a fundamental reason for persistent USD underperformance. Unless inflation delivers material downside surprises today or tomorrow, the conditions appear in place for to return to 99.0.
EUR: ECB Can Disappoint the Hawks
EUR/USD climbed to 1.650 yesterday before reversing after the US Treasury announcement. The initial rally was driven by a sizeable 7-8bp tightening in EUR/USD two-year swap differentials, entirely the result of an almost 10bp rise in the euro leg. That likely reflected spillover from another rise in energy prices and perhaps some positioning for a hawkish ECB message today.
On the latter, we aren’t convinced. As discussed in our ECB cheat sheet, there are some downside risks for the euro today. Markets now price 50bp of tightening by year-end and 85bp by July, leaving the ECB with a high bar to meet. While today’s widely expected 25bp hike can still be framed as an insurance move, further hikes would push policy further into restrictive territory. We doubt the ECB is ready to semi-commit to another hike by year-end, as it did in July, for two main reasons: a) the inflation projections are unlikely to justify it; b) concerns may be building around the eurozone bond market.
To be clear, we don’t think the ECB will be intentionally dovish. But retaining broad optionality on further tightening seems too little to satisfy markets’ hawkish bets. We expect some repricing lower in the EUR curve to pave the way for a retest of 1.160 ahead of next week’s FOMC (where we expect a hike). Our one-month target remains 1.150.
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