Morning Commentary: ECB: Balancing Progress, Pressure and Pitfalls

Foreign Exchange - Morning Commentary
ECB: Balancing Progress, Pressure and Pitfalls
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Andrew Kositkun
Andrew Kositkun
Foreign Exchange Head Trader
At the European level, the strong political message against fragmentation risk has helped with the prospects of an economic recovery.  Despite this, the ECB, who meets tomorrow morning, still needs to do more.  

When the ECB announced its Pandemic Emergency Purchase Programme (PEPP), it only had a rough idea of what the economic impact from COVID-19 would be.  Since then, data shows that the shock was larger than originally expected with the impact lingering longer than hoped.  A larger economic impact lends itself to a larger funding need.  Even when factoring in all the EU backstops fully accounted for, more work remains.  This makes the case for the ECB to eventually upsize its PEPP program and extend it well into 2021.  

While it is fairly clear more stimulus will be needed, the ECB likely does not go “all in” this month.  Likely the ECB will elect to take a “wait and see” approach in order to gather more data and keep pressure on governments to act (see European Recovery Fund).  Come September, there should be more clarity around what fiscal support will be provided by the European Recovery Fund as well as Q2 GDP data, the ability for the German central bank to participate in ECB programs and a measure of how normalization is going.  

Should the ECB choose to wait for its “all in” moment as expected, it will still need a bridge to September.  By putting in place a small increase to PEPP, the ECB can make it clear that the current pace of purchases is sustainable through the end of the year.  Moreover, the uncertainty around the recovery supports a piece-meal approach.      

Beyond the changes to ECB’s programs, expect the markets to focus on ECB comments relating to the German Constitutional Court’s ruling.  The European Court of Justice’s position is clear—it has approved the ECB’s programs—but that doesn’t mean olive branches won’t be extended.  The ECB’s most recent set of meeting minutes went into the pros and cons of asset purchases in greater detail than normally done.  This maneuver strikes the delicate balance between addressing the German court’s concerns without directly acknowledging them as the ECB is technically outside the jurisdiction of national courts.  Expect markets to keep an eye on whether the recent conciliatory tone out of Europe continues.  
  • Markets are still rolling with the punches as risk on sentiment continues despite continued growth downgrades, increasing COVID-19 infection rates in key EM countries, civil unrest in the US and US-China tensions.  These factors have led to USD weakness with the dollar trading down to its lowest levels since the first half of March. 
  • US ADP employment data came in better than expected with the US losing 2.76 million jobs against expectations for a loss of 9.0 million jobs.  The government’s employment report comes out this Friday with market consensus for a loss of 8.0 million jobs.  US ISM Non-Manufacturing PMI also beat expectations at 45.4.
  • The BoC held rates steady at 0.25% as expected.  
  • Brexit news continues to be volatile.  Yesterday brought reports that progress was being made on Brexit talks, but today UK sources pushed back on the suggestion that they were ready to compromise.  This type of brinksmanship isn’t surprising given the history of Brexit negotiations and markets, so far, have been shrugging off the latest clash.  
  • Germany’s most recent stimulus plan hit a snag in negotiations but a compromise is still expected to be reached.  
  • Australia’s Q1 GDP came in better than expected with the economy contracting -0.3% against expectations for a -0.4% decline.   
  • Eurozone unemployment rose to 7.3% from 7.1% prior but beat expectations for a rise to 8.2%.  Composite PMI data also beat expectations at 31.9 versus consensus for 30.5.  This print confirms that the European economy is still contracting but suggests that the unprecedented contraction in activity is beginning to moderate.  
  • Saudi Arabia and Russia are holding a hard line over production cuts and want a full commitment from countries that are known for cheating that they will fully implement cuts.  These developments put uncertainty around the ability to extend production cuts.  
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