EUR And ECB: Dovish For Bonds, But Not For EUR

ECB frontloading PEPP purchases isn’t a negative for EUR/USD. It helps to underscore the latest market narrative of tentative stability in core bond yields, in turn taking away support from USD. EUR/USD to move above 1.25 in summer. The main winner from the subsequent stability in core bond markets is EM FX, mainly the high yielders that got hit last month.

Frontload PEPP purchases is not bad news for EUR/USD

The European Central Bank surprised with the announcement of frontloaded Pandemic Emergency Purchase Programme (PEPP) purchases (see ECB Review), but in terms of the dovish impact on underlying eurozone assets, this is more a story for the eurozone bond market than the euro itself.

As we argued in the ECB Cribsheet, as long as the whole PEPP envelope is not extended, the negative impact on the euro should be limited as this only changes the pace of the bond purchases, but not the overall size. For a more meaningful (negative) impact on the euro, the size of the PEPP envelope should have to be increased. Such a potential move from the ECB is still rather far away and unlikely, in our view.

If anything, the ECB decision to lean against the rising bond yields is a positive for EUR/USD as more bond-buying helps to underscore the very latest market narrative of the tentative stability in core bond yields. This in turn is (a) negative for USD, the key beneficiary of the UST sell-off in February (largely because it triggered a positioning squeeze in G10 and EM currencies), and (b) positive for cyclical FX and also for EUR/USD.

Moreover, the fact that the ECB language is now less downbeat (‘’risks have become more balanced’) has also helped to offset any dovish impact from frontloading the PEPP purchases on the euro.

Constructive EUR/USD outlook

We reiterate our bullish EUR/USD view. Not only does today’s ECB decision help to limit the key USD tailwind of late (sharply rising UST yields), but as the eurozone economy starts to recover in the second quarter (with the pace of vaccination set to increase), EUR/USD should start moving higher, further helped by the deeply negative US front-end real rates (note: US CPI should push above 3.5% during 2Q). We thus expect EUR/USD to move above 1.2500 this summer.

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