In recent days, Eurozone government debt markets had been showing signs of increasing stress.
Ever since Lagarde said “it is not our job to tighten spreads” (i.e. the difference in the interest rates being paid by the Germans and Italians for new debt, for example), spreads had been widening. Indeed, the interest rate on Italian 10 year debt had shot up to 3% from less than 1.5% a week ago.
Her statement at the time had been taken as “we are not willing to do whatever it takes to save the Eurozone”, a reversal on prior President Draghi’s famous “we will do whatever it takes” moment.
As such, traders were beginning to lose faith that the ECB would be willing to step in to save the Eurozone should everything go south.
But overnight the ECB made a sharp reversal on this stance.
A huge EUR 750bln QE programme was announced that, at the moment, is set to run for the duration of the year, although the ECB added that it is prepared to raise the size of any purchase programme and adjust its composition by as much as is necessary and for as long as needed.
Moreover, ECB President Lagarde was quickly on the newswires saying that extraordinary times call for extraordinary measures and there are no limits to our commitment to the Euro.
In other words, after last week’s underwhelming meeting and a communication mishap that resulted in a significant widening in Eurozone yields spreads, Lagarde had realised that, in the current Covid-19 crisis, it is go big or go home.
Lagarde’s change in heart appears to have done the trick. The spread between 10y bunds & 10 year Greek and German bonds has fallen by a whopping 170bps today, while yields on Italian 10 year debt is now back in the 1.5% region, from highs of around 3% yesterday.
How does this all translate into FX markets?
Normal FX market fundamentals appear to have broken down in recent weeks. Normally a hugely dovish move like this from a central bank such as the ECB would cause huge weakness in its currency, in this case EUR.
But FX markets have been trading off of a different theme as of late; that of liquidity. Or more precisely, whichever currencies have more liquidity have tended to perform better.
For this reason, as we have been emphasising to our members repeatedly in recent days, USD has been the solid outperformer. In a market climate where you want to sell everything and hold cash, what better currency to buy that the most liquid currency in the world and the the most important reserve currency in the world… the USD!
As the world’s second most liquid currency, EUR has also held up well. Admittedly not as well as USD, hence EURUSD is back in the low 1.08s, but well against most of its other counterparts.
But given the size of the Eurozone economy, EUR has not been nearly as hard hit as the likes of GBP, AUD, NZD, CAD, NOK and SEK.
The only other currencies performing well in this climate are havens, i.e. JPY and CHF.
In terms of today’s action from the ECB, you might not be seeing it in EURUSD (due to USD strength today for the reasons I explained above), but I expect this to be a general positive, as it is likely to strengthen confidence that the Eurozone economy can weather this storm.