Thoughts on Jackson Hole
Draghi praised the benefits of economic openness at Jackson Hole, highlighting the benefits of a dynamic global economy. This could be interpreted as an objection against the latest rout of US economic policies and actions from the Trump Administration, i.e. NAFTA renegotiation, the wall with Mexico, proposing to abandon the NATO, abandoning the ITPP, etc.
Ultimately for markets, Mr. Draghi was neither hawkish nor dovish with regard to the euro (FXE) or the Eurozone, which was welcomed by the single currency. The euro lost momentum in August, especially after Reuters informed that the ECB’s President was not going to give updates on monetary policy, which was interpreted as a somewhat dovish signal by markets.
What comes next for the euro?
The euro however had been strengthening considerably since the end of June. This uwpard trend begun after Draghi’s intervention at the European Central Bank Forum in Sintra (June 27th), when he said that “reflationary forces are working their way through the economy”. The euro received another boost on the last ECB meeting (July 20th) when Draghi said the central bank would revise its monetary policy in autumn.
Now markets turn their attention to the next ECB's monetary policy meeting on the 7th of September. However, I do not expect Draghi to announce any changes on monetary policy on the next meeting. The reasons are:
- There has only been only one more inflation release since the last meeting, and no more releases are expected before September's meeting (August's CPI flash estimate is released on August 31st, but it is based on energy prices and 13 countries only--the ECB will watch more closely the final figures).
- The ECB’s mandate, as of today, is price stability only. It seems more plausible the Governing Council will stay put, at least, until October's 26th meeting. This would allow the ECB to study two additional inflation releases. (August's final CPI figures are released on September 18th, and September's final ones are released on October 17th).
- The German elections take place on the 24 of September. It appears that markets are considering the German elections as a non-event. It is true that a victory by Merkel is very likely, but recent history has taught us to never be complacent. I expect a victory by Ms. Merkel, but I would also expect some volatility before the elections. The ECB would clearly not risk making a move before the elections.
Ultimately, a victory by Merkel would help to consolidate a Franco-German alliance in the core of the Eurozone, which would further ease worries at the central bank and support a reconsideration of the strategy of monetary policy.
Should SPD’s Mr. Schultz defeats Ms. Merkel next month, new concerns would grow about the future of the single currency area, which would lead to sharp increases in risk premium's across the entire Eurozone and could delay indifinetely any change in monetary policy by the ECB.
Looking at EURUSD 1-month risk reversals, whose tenor now includes the German elections, show that markets remain too unworried about the upcoming elections. Markets are paying a premium for call options a month in advance, as opposed to put options should markets be purchasing protection against downturns in EURUSD--as it happened before the French elections when markets were paying huge premiums to avoid downside risks in the euro.
Hence, I do not expect Draghi to announce changes on monetary policy in September. The ECB’s President would likely to reiterate that the Eurozone’s economy continues to recover, that such recovering is becoming independent of the monetary policy, and that the current degree of monetary accommodation remains needed to return to the 2% inflation target. If any, the ECB would hold fire until, at least, October's 26th meeting.
As a result, the euro could fail to reach new highs above 1.20. The result of the German election will be the next key driver of euro related crosses, and I would expect the single currency to continue to strengthen by the end of September.
PS: The Federal Reserve will meet again on September 20th.
Disclosure: I am/we are long FXE.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.