Currency moves can be "brutal," as the ECB well knows, since then-ECB President Jean-Claude Trichet used that memorable adjective more than a decade ago. The problem for the ECB is it may be heading down a dark alley where two well-armed peers await. Investors have reasonable clarity about the medium-term policy outlook for the U.S. Fed and Bank of Japan, with both central banks effectively anchoring long-term rates. The Fed’s dot plot, along with senior policy makers’ comments, have cemented the idea that the benchmark rate will top out at 3 percent, a level that won’t be reached for years. The BOJ has explicitly frozen long-term bond yields through its yield-curve control, and Governor Kuroda made crystal clear two weeks ago that he’s not about to embrace stimulus tapering.
While incoming data could still sway traders’ views on the Fed and BOJ, the scope for significant shifts is minor compared with the lack of visibility on the part of the ECB, where there’s long been a dissident minority in favor of tightening.
After Draghi roiled the euro this week, parallels were drawn to the Fed-induced 2013 taper tantrum. While the reaction has hardly been comparable, there’s a deeper parallel to consider: the euro zone financial and economic cycle is years behind the U.S. one, with households and banks still shaking off the legacy of the debt crisis.
Given the Fed is effectively the dependent variable and the ECB the independent actor, the ECB "can’t control the correction" in the euro if it maps out a path to normalization, as Societe Generale puts it. Throw the BOJ in there as another dependent variable, and it puts both euro-dollar and euro-yen in play.
As happened with the Fed’s stop-and-go pattern in the years after 2013, the ECB could be heading toward a patchy period where it periodically suspends stimulus withdrawal as it considers "brutal" moves in the euro that hurt the outlook for growth.
It’s not only the ECB that’s in a tough spot, but policy makers in the U.K. and even Australia, where one former Reserve Bank board member this week floated the possibility of a steep set of rate hikes in the coming two years.
There are still wild cards for the Fed and BOJ, not least that both their chiefs are facing looming expirations of their terms in early 2018. The Fed heads into uncharted territory when it starts shrinking its balance sheet, though the signal from markets for now is that investors are comfortable the process will be painless....