ECB's Next Challenge

Thursday's ECB meeting is perhaps the least straight-forward central bank decision in recent memory. All currencies are currently weaker vs USD except for CHF. The rebound in risk trades extends to European indices as US equities edge back in futures activity. UK jobs creation slowed in August but wages growth of 4% continue to outpace 2% inflation.

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Markets featured light USD selling on Monday as Treasury yields ticked higher. The pound benefited from a strong GDP report in a rally to a five-week high. UK parliament will now take a break until mid-October as Johnson failed to trigger an election. He will attempt to obtain a deal from the EU, which remains far-fetched.

Upbeat economic news continued Tuesday as wage growth grew at a faster pace than expected. UK politics will continue to weigh heavily on FX but the short-term intrigue surrounds Thursday's ECB decision.

The latest hints from the ECB suggest rate cuts and perhaps no further QE. The aim may be to lower short-term rates while keeping the longer end higher in order to stimulate lending. If so, the result could be to sell the euro. At the same time, the market has been conditioned to expect a 'surprise' from the ECB so it's difficult to agree on what's priced in. Forecasts for a rate cut range from -10 to -25 bps.

One scenario is for the ECB to disappoint, raising questions about the health of the Eurozone economy, in which case, the euro could underperform in the medium term after a short-term pop.

Part of the strategy is surely to nudge governments into expanding fiscal policy to pick up the slack in the economy. There is an increasing idea in markets that a harder line will be a hallmark of Legarde's presidency and Draghi may help to usher that in with less-stimulative action.

That message may already be filtering through as the euro climbed Monday on a report saying Germany's government may set up special entities outside of the budgetary system in order to borrow and invest in infrastructure and green projects. Expect those types of reports to increasingly steal the FX spotlight away from tapped-out central banks.