Macro Strategy: ECB and euro; PBOC policy

Further EUR strength discouraged; China curve higher but not steeper
Philip Wee, Eugene Leow27 Nov 2020
    Photo credit: Unsplash Photo

    FX Daily: ECB doesn’t need a stronger EUR 

    Currencies were broadly unchanged in overnight markets. Wall Street was closed on Thanksgiving Thursday and will end early on Friday. US stock market futures, which are poised to open weaker today, are likely to take the driver’s seat during the Asian and European sessions today. US 10-year treasury yield held within 0.85-0.90% in the past two sessions. Gold has been pivoting around USD1810/oz since Tuesday. WTI crude oil prices, however, tumbled to USD45/bbl from USD46, the session’s high yesterday. Our views have not change from yesterday’s Daily (click link here) that currencies will continue to consolidate and test key reistance levels. 

    The European Commission will release its Economic SentiMent Indicators this evening.Consensus expects overall economic confidence to fall to 86.0 in November from 91.9 a month earlier. As per the PMIs out on Monday, services is likely to have taken the brunt (-16.3 consensus vs -11.8 previous) of the lockdowns and tighter restrictions to curb the coronavirus resurgences across Europe. Industrial confidence is expected to weaken to -10.9 from -9.6.

    Against this background, the European Central Bank has paved the way for more monetary stimulus at the next governing council meeting on 10 December. The ECB is likely to avoid changes to interest rates and centre around the pandemic emergency purchase programme (PEPP) and the targeted longer-term refinancing operations (TLTROs). Why?


    Despite the extraordinary policy responses during the pandemic, overall monetary conditions in Europe have not eased but were, as of October, at their tightest since August 2011 and April 2010. The responses have ensured that the running of an effective monetary policy by stabilizing markets and protecting credit supply. Delivering on its price stability mandate would require the ECB to address the tightened financial conditions from real interest rates (the tightest in 12 years) via negative inflation and a stronger real euro (tightest since January 2010). Herein lies the rationale why the ECB does not need a stronger EUR from here but for EU leaders to deliver the EU Recovery Fund, which is still blocked by Hungary and Poland, without delay. 

    China rates: Stimulus withdrawal 

    In relative terms, the People’s Bank of China (PBoC) has been one of the most aggressive in terms of normalizing monetary policy.Short-term and long-term CNY interest rates are already back to pre-COVID-19 Pandemic crisis levels. However, judging by the actions and comments by the authorities, a further modest rise in rates cannot be ruled out. There are several points to keep in mind as we formulate the strategy for onshore rates.

    CNY interest rates tend to move according to how the economy is performing. Clearly, this is due to the PBoC’s response function. While the Fed and most other central banks are worried about growth risks, the PBoC appears to place a higher weighing on inflation and financial stability. Moreover, PBoC did not do quantitative easing (buying of government bonds), partly accounting for why CGB yields did not fall as much during the acute phase of the Pandemic crisis in 1Q and 2Q.  Accordingly, when China contained the virus and the economy picked up subsequently, the pace of tightening (via the liquidity route) proved to be rapid, with the 3M SHIBOR back at 3.1%. The flatness of the yield curve (2Y/10Y) suggests that policy settings already have a hint of tightness. 

    We think that the CGB curve will level shift higher (keeping to the relatively flat profile) with 10Y yields drifting towards 3.4% before stabilizing. Notably, bear markets in the CGB space can last beyond a year. If China growth gets positive impetus from a bounce in the global economy, overheating risks may materialize. If so, the PBoC should be more responsive than DM peers. That said, if real rates stay relatively high for China, the currency should hold up, providing a tailwind for foreign investors. In any case, with the PBoC far along on normalization and CGB already offering decent yield, total returns (in CNY terms) for 10Y CGB would still be positive even if yields rose to 3.5%. By contrast, we expect total returns for 10Y UST to be modestly negative for 2021. 

    Philip Wee

    FX Strategist - G3 & Asia

    Eugene Leow

    Rates Strategist - G3 & Asia

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