Draghi Set to Boost Euro, Weigh on Bonds as Political Risks Dim

(Bloomberg) -- Buy the euro, sell bonds.

That’s the takeaway from strategists who expect that the European Central Bank President Mario Draghi will announce Thursday an end to the institution’s asset-purchase program as the immediate risks surrounding Italian politics subside.

Analysts have become more bullish on the euro following recent hawkish comments from ECB officials, with Credit Agricole SA forecasting that the shared currency will climb 7 percent to $1.26 by year-end. Money market pricing indicates that interest rates will rise 15 basis points in September 2019.

Traders have been emboldened by policy makers including ECB Chief Economist Peter Praet, who signaled last week that the meeting could be pivotal in deciding an end-date to quantitative easing.

“That the ECB’s chief economist is still talking about policy normalization, even as the Italian political crisis rages, reinforces our belief that euro-dollar will get to 1.30 in the next six to 12 months,” Societe Generale strategist Kit Juckes wrote in a note to clients. The pair currently hovers around $1.1750.

JPMorgan Chase & Co. recommends going short on longer-dated German bunds and Deutsche Bank AG prefers selling the front end of the yield curve. Meanwhile, a potential stumbling block to Morgan Stanley’s steepening recommendation in bunds or euro interest-rate swaps is uncertainty over the outlook for Italy, according to the bank.

Here is a compilation of analyst views:

JPMorgan

  • Recent hawkish ECB commentary is “one surprisingly supportive development for EUR,” write strategists including Paul Meggyesi
  • Predicts EUR/USD at 1.23 by mid-2019
  • “We hold 30y Bund shorts as a more hawkish ECB offsets Italy and trade-war concerns,” write strategists including Gianluca Salford
  • Expects ECB to announce QE tapering at this meeting for the fourth quarter at EU15b per month, ending in December

Deutsche Bank

  • “We maintain our strategic approach of being short the front-end of the curve to position for a repricing of the ECB, while maintaining asymmetric hedges such as the German spread curve flattener,” write strategists including Francis Yared
  • “The ECB will not be derailed by Italy as long as there is no ‘unwarranted tightening of financial conditions’ ”
  • Market pricing appears too dovish; even if the ECB were to follow a Taylor rule applied to Italy, policy rates would need to be ~50bps above current levels

Credit Agricole

  • ECB likely to maintain a “relatively constructive outlook for the economy and that should be reflected in the updated staff economic projections,” head of G-10 currency research Valentin Marinov writes in a note
    • Remains constructive on the euro as a result and predicts EUR/USD at 1.26 by year-end

Morgan Stanley

  • “While the end of QE might be announced, our view is that, for now, the ECB will keep its cautious guidance around interest rates,” strategist Elaine Lin writes in a note
    • Recommends investors put on a 2s10s steepener trade via Bunds or EUR swap -- the risk to the trade is higher perceived uncertainty about the Italian outlook, which could trigger more flight-to-safety flows into the 10y sector

©2018 Bloomberg L.P.

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