The clear blue water of policy divergence that became apparent in the final quarter of 2015 now seems muddied.
The European Central Bank (ECB) suggested that the marginal efficacy of monetary policy is declining when ECB President Mario Draghi stated at the 10 March press conference that its scope to cut interest rates further is limited. Market reaction to comments from the Federal Reserve (Fed) has flip-flopped, with the central bank being viewed as decidedly dovish in April and subsequently hawkish in May.
While the Fed is currently expected to hike rates this summer in response to stronger data, any stumble will produce a strong counter trend and the narrative will change once again. Ultimately, central banks respond to economics. The potential schism in economic paths has created unusual currency reactions over the first half of 2016 and these could well continue.
We would note that the EUR/US$ is at the top of its recent trading range. In addition, investor positioning appears to have switched to short US$. In this environment, we believe a tactical opportunity to short EUR/US$ has been presented. There is also a case to be long the US$ given the more hawkish tone from the Fed.
Paul Lambert – Insight Investment, a BNY Mellon company