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Forex Blog - Trichet Plays Zeus Protector of Price Stability in Athens Thursday


Trichet Plays Zeus Protector of Price Stability in Athens Thursday


While the market seems intent on buying dollars and selling euros making status quo outcome of Thursday’s ECB press conference only mildly bearish for the dollar, the notion that President Trichet and the Governing Council are ready to shift the focus of policy from inflation to growth.  Not with oil at $123 a barrel and rising. Not with elevated food prices. Not with inflation expectations creeping higher.  Not with data from the US suggesting a shallow downturn.  Not with German wage settlements running high.  Not with Euro Zone inflation running north of 3%.  Not with the liquidity measures risking an inflation outburst down the road.  Not with the Fed underwriting the downside of global growth by taking the Funds rate to 2% from 5.25% in 7 months.  And certainly not with euro/dollar moving from 1.60 to 1.54 in the last three weeks – which arguably was the most compelling reason for an early start to easing by the ECB since the credit crisis unfolded last summer.


Like Zeus atop Mount Olympus, Trichet is comfortable in his perch atop the ECB and quite happy playing the protector of price stability one more time in Athens this week.  Trichet knows growth is slowing in the Euro Zone, but that has been part of the operating assumption since Q4 and growing slightly below potential is neither a necessary nor sufficient condition to introduce “two-way” risk on interest rates.  I also think the recent drop in April CPI to 3.3% year-over-year from 3.6% in March offers little comfort to a central bank whose mandate is to keep inflation under 2%.  In the April press conference Trichet and the GC acknowledged downside risks to growth prevailed and the outlook for growth was uncertain in light of financial turbulence (could last longer and have more impact on real economy), rise in food and fuel prices (reducing disposable income, consumption) and the usual risk of disorderly unwind of global imbalances (dollar crisis).  What has changed on this front in the last 4 weeks is that data on confidence, retail sales, industrial orders and trade suggest more headwinds for the Euro Zone.  But not enough, we think, to make a case for backing off on inflation and introducing a path to lower rates, even in due course.  This Zeus needs more than a few data points to fundamentally change his medium-term view on growth…more data gathering (waiting) is the likely message Thursday.


Back to euro/dollar – markets have priced in more and earlier accommodation from the ECB than is likely the case for Thursday’s meeting.  The eye of the hurricane in credit markets, equities, currencies and bonds is proving to be quite wide and if anything the current easing of credit conditions (still historically tight) make an earlier move to accommodation unlikely.   We think there is potential for a bounce in euro/dollar tomorrow (firmer commodity prices aiding this trade).   But the current mood remains one where buying dollars is proving more rewarding and even the slightest hint of a shift in the balance of risks by the ECB could put euro/dollar on a fast track to 1.50.  Risk reward is still in favor of sellers of euro/dollar near-term no matter how much I think the dollar has yet to put in a long-term bottom.  Of the 3 conditions for a dollar bottom/turn set forth in prior emails, only one condition has been met and only partially – Fed signaling it is done easing (I believe in the tooth fairy too).  The ECB has yet to signal potential for rate cuts, and won’t tomorrow, and joint currency intervention is quite remote in the currency environment with the dollar rallying nicely on its own.  I think the 3 conditions come together later this summer or early this fall (by September G7 in Washington).


David Gilmore   


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