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FX Daily18 .pdf


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Author: John Horner

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Deutsche Bank
Markets Research
Global

Foreign Exchange
FX Spot

Date
7 November 2013

FX Daily
Beware the squeeze - can't get excited
with ECB
We don't think it is a big deal if the ECB cuts interest rates in December, or even today.
Cash EONIA is already at 9bps, not rising to 25bps until January 2015. There is a bit of
room for 2016 rate expectations to drop, but big picture two things matter more:
First, what does the ECB say about the future? Indicating that the probability of negative
rates has increased would be very dovish. Shifting the balance of price stability risks to
the downside would also be dovish. The trouble is that it's tough to see either
materializing, not least because the data pulse remains close to the ECB baseline and
negative rates are politically explosive. The risk is therefore that following a potential rate
cut (if at all), the market is left concluding that the ECB easing cycle is complete rather
than having more to go - typically associated with relief rallies in yields/FX not weakness.
The second thing that matters is ECB liquidity policy. Even if the central bank cuts rates,
cash EONIA is well below the refi target, at a time when excess liquidity in the
Eurosystem has declined below the 200bn threshold level. This means that a cut
notwithstanding, the risk is that short-dated euro yields grind higher. To be sure, the ECB
can offer an additional LTRO to ease the pressure. The constraint is that unlike QE, an
LTRO is demand-push rather than supply-push liquidity: banks will determine how much
new cash is taken up. At best, we see banks rolling over their existing liquidity into a
longer-dated LTRO, but this will do little to increase the overall size of the ECB balance
sheet and will bear little resemblance to last years' liquidity injections.
In sum, we can't get too excited by the ECB meeting. We estimate the market is pricing
around a 50% chance of a cut by December, while we think it is less, and the mediumterm impact will be low. We therefore see the risks skewed towards a EUR/USD squeeze
higher today. Bigger picture, the US side of the equation matters more. US short-end
expectations remain very subdued, helped by increasing focus on the potential for
extended forward guidance from the Fed. We see the risks as asymmetrically skewed
towards higher US rates and a resumption of the stronger dollar theme as we head into
next year, but unless the ECB sounds far more dovish than usual that’s not a story for
EUR/USD today.

ECB Rate Cut Can’t Have Big Impact on Rates

Low Excess Liquidity Means Cash Rates Can Grind Up
90%

2.25

80%

2.00
1.75
1.50
1.25
1.00

0.75
0.50

cash EONIA can go up
even if ECB cuts

curve can flatten
here if ECB cuts rates

0.25
0.00
Spot 3M 6M 9M 1Y 15M 18M 21M 2Y

3Y

Market expected EONIA rates

4Y

5Y

6Y

(Eonia - Depo) / (Refi - Depo)

2.50

200bn threshold

70%

Forwards

60%

Current EONIA

50%
40%
30%
20%
10%
0%
0

200,000
400,000
600,000
Excess liquidity in EUR mn

800,000

Source: Deutsche Bank, Bloomberg Finance LP

________________________________________________________________________________________________________________
Deutsche Bank AG/London


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