Draghi’s Attempt to Talk Down Euro Lost on Traders: Currencies

As far as currency traders are concerned, it’s going to take more than words for European Central Bank President Mario Draghi to weaken the euro.

The 18-nation currency has slipped 0.5 percent against a basket of nine developed-market currencies since Draghi said March 13 that the exchange rate is “increasingly relevant in our assessment of price stability.” That compares with a drop of 1.8 percent for the yen and a 0.3 percent gain for the dollar, Bloomberg Correlation-Weighted Indexes show.

The ECB, which meets tomorrow, is under pressure to stem a 20-month advance in the euro that has weighed on growth and slowed inflation to barely a quarter of its 2 percent target. Among the actions Draghi may take are cutting the central bank’s record-low interest rates or stop mopping-up the excess liquidity from its asset-purchase program.

“The time for talk is over and measures must be implemented,” Neil Jones, the London-based head of financial institutional sales at Mizuho Bank Ltd., said in a phone interview yesterday. “Talk is not going to do it. Verbal intervention is insufficient.”

Exceeding Forecasts

Euro bears may need to be patient. Policy makers will keep their benchmark rate at a record 0.25 percent, according to all but three of 57 economists in a Bloomberg News survey. One sees a cut tomorrow to 0.1 percent while two call for 0.15 percent.

The euro strengthened 8.1 percent over the past year, snapping four straight annual declines from 2009 through 2012, according to Bloomberg Correlation-Weighted Indexes.

Like last year, the euro has performed better than predicted in Bloomberg strategist surveys. The 18-nation currency strengthened 0.2 percent to $1.3769 in the first quarter, compared with a median prediction for a 3.2 percent drop to $1.32. At the end of 2012, strategists were projecting a decline to $1.27 by end-2013, which turned out to be 8.2 percent lower than its $1.3743 Dec. 31 close.

Jones sees the shared currency climbing to $1.40 this year, from $1.3763 at 12:23 p.m. in New York. The median forecast of contributors in a Bloomberg survey is for the euro to finish this year at $1.30.

The euro has been supported by signs that the region’s economy is gathering steam, after Draghi pledged to prevent the currency bloc from splintering in July 2012.

ECB’s Dilemma

While the euro’s strength is a tribute to Draghi’s success in calming nerves at the height of the sovereign-debt crisis, it risks stymieing a recovery struggling with almost record-high joblessness.

Purchasing-manager indexes released last week showed factory and services activity in the first quarter was the strongest in almost three years, and confidence in the region was the highest since 2011. In the euro-area, the jobless rate was at 11.9 percent in February, while in Italy it climbed to 13 percent, underscoring the dilemma facing ECB officials.

“The PMIs show the euro-zone is not contracting -- it’s a stagnation, but some are calling it positive growth,” Marc Chandler, the global head of currency strategy in New York at Brown Brothers Harriman & Co., said in a phone interview on March 31. “That all will buy the ECB time because the next step the ECB may have to take is more drastic, such as a deposit-rate cut to negative yields. That’s a nuclear option because the ramifications are hard to know.”

Unwarranted Pressure

Draghi’s March 13 comments were the latest example of ECB officials becoming more vocal about the currency’s strength. He said March 6 that the exchange rate had cut 0.4 percentage point off inflation. Governing Council member Christian Noyer was more forthright four days later, saying a stronger euro creates unwarranted pressure in the economy.

Traders are betting that the euro’s resilience will endure, as shown by measures in the derivatives market ranging from future volatility implied by option prices to the cost of insuring against a drop in the single currency.

The 25-delta one-year risk reversal rate was at a 1.03 percentage-point premium for euro puts, which grant the right to sell the currency, over calls, the least since February 2013 based on closing prices. That’s down from the 2014 high of a 1.39 percentage point premium on Jan. 2.

Implied volatility on three-month options for the euro-dollar pair is at 6.5 percent, down from a peak last year of 9.5 percent in February, signaling traders see less chance of big swings in the euro.

Bears Setback

Hedge funds’ and other large speculators’ bets on the euro were 39,634 contracts in favor of appreciation on March 25, according to the Washington-based Commodity Futures Trading Commission. That compares with a net-short position as recently as mid-February.

Another setback for euro bears came this week, when Federal Reserve Chair Janet Yellen said on March 31 that “considerable slack” in U.S. labor markets showed that the central bank’s accommodative policies will be needed for “some time.”

Yields on U.S. fixed-income assets became more attractive to investors after traders began to price in a rate increase in the middle of next year. Two-year Treasuries yielded about 0.3 percentage point more than German bunds last month, up from 0.07 percentage point in December.

“We are not going to see higher rates in the U.S., for as much as people talk about,” Axel Merk, the president and founder of Merk Investments LLC in Palo Alto, California, said in a March 31 phone interview, predicting that the euro will climb to $1.50. “So the U.S. isn’t quite as great a place to invest in and Europe isn’t quite as bad a place to invest in.”

Deflation Threat

A report this week showed euro-area consumer prices rose an annual 0.5 percent in March, compared with the ECB’s target of just below 2 percent, raising the specter of a Japan-style era of deflation that discourages investment and spending. Prospects of ECB action faded after Governing Council member Jens Weidmann, who’s also head of Germany’s Bundesbank, said March 29 that officials should only react to “second-round effects” of slowing inflation, which aren’t evident currently.

“There isn’t enough confidence that the ECB will respond to the disinflation we’ve seen so far,” Henrik Gullberg, a London-based currency strategist at Deutsche Bank AG, said in a phone interview on March 31. Traders “need the ECB to respond to disinflation” before selling the currency and using the proceeds to invest in higher-yielding assets, he said.

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