Toxic macro and monetary mix spells danger for the EUR; piles pressure on SNB

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The resilience of the EUR after last week’s European Central Bank (ECB) meeting reflect concerns that other main central banks could pursue further easing measures, but negative rates and weak demand for eurozone assets do not bode well for the single currency.

Admittedly, the EUR sold off after the ECB downgraded its 2013 GDP forecast to -0.3% from +0.5% and predicted CPI would fall below its 2% target in 2013 and 2014. However, the fact that EURUSD found support around $1.29 might come as a surprise, given that the Eonia futures curve subsequently shifted to price-negative overnight interest rates in the eurozone for the first time ever.

Forward EONIA shifts into negative territory

 Source: Bloomberg
Chris Turner, head of FX strategy at ING, says the prospect of negative overnight interest rates should be a reminder that eurozone money-market funds will not be the place to invest in 2013. The chart below underlines the fact that portfolio flows are a substantial driver of EUR pricing.

Weak demand for eurozone assets should hit EUR

 Source: ECB, ING
“Flows into eurozone money-market funds were a key driver of EURUSD strength in 2009,” says Turner. “Net money-market outflows could weigh in the EUR in 2019.” Furthermore, if eurozone growth does come in at -0.3% in 2013, flows into eurozone debt and equities look unlikely as well. “We expect eurozone residents will increasingly have to look outside the eurozone for returns in 2013, which will weigh on the EUR,” says Turner. Of course, there looks little to choose between the USD, EUR, JPY and GBP heading into 2013, with each leading central bank looking for a weaker currency. “However, the macro/monetary mix looks quite negative for the EUR in the early part of 2013 and that’s why we are still bearish,” says Turner. ING forecasts $1.20 for EURUSD at the end of Q1 2013 and believes the 40 basis points available in UK overnight rates should see GBP start to strengthen. The bank has a Q1 2013 forecast of £0.78 for EURGBP. While that news is unlikely to be welcomed at the Bank of England, the Swiss National Bank (SNB) will be watching the development on the eurozone rate just as avidly. Figures showed the SNB did not have to intervene to maintain the SFr1.20 EURCHF floor last month amid reduced concerns over the viability of the eurozone project. Increased worries about Europe’s economy could change that, and put the SNB’s currency strategy back in the spotlight. This week’s SNB policy meeting could give the central bank a chance to get ahead of the curve, with the introduction of negative Swiss rates or some form of capital control not out of the question.