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The Draghi effect keeps rolling; Deutsche Bank’s euro bears give up

Love it or hate it, for now you stand in the way of the Draghi Effect at your peril.

The euro is still ploughing higher while eurozone government bonds are falling after European Central Bank chief Mario Draghi yesterday used the R-word (reflation), stoking expectations that policymakers are seriously considering how to withdraw from their long-running stimulus measures. No matter than Mr Draghi was also at pains to stress that any such move would need to be done with “prudence”. The market has picked up the ball and run with it. (More from the FT on this here.)

Here’s what the European Central Bank kremlinologists think:

Deutsche Bank is taking it seriously enough to scrap its euro forecasts and jack them much higher. George Saravelos there writes:

We are completely revising our euro outlook for the rest of the year. The speech is not the fundamental driver behind the change in view, but it aptly marks the culmination of a number of developments that have caused us to change our forecasts. We accordingly now expect the euro to rise to $1.16 or above by the end of the year (previous year-end forecast: $1.03).

Our main message is that the the euro is likely to be the key vehicle via which financial conditions in the Euro-area will be tightened. This could well mean that, like the Fed’s exit, the ECB is unable to tighten as much as it thinks.

Neil Mellor at BNY Mellon is not blind to Mr Draghi’s caveats, but still respects the shift:

There are limits to any hawkish interpretation of testimony which assures that a “considerable degree” of stimulus is still needed, but it is difficult to refute the conclusion that Mr Draghi took a very small step forward on the long road toward policy normalisation in the second of his two speeches this week – notwithstanding the contentious suggestion that “considerable” is an irrefutably hawkish substitute for “very substantial”.

Derek Halpenny at MUFG (among others) thinks the market has gone too far.

Low volatility and calm market conditions breathes complacency and can result in out-sized moves relative to the fundamental explanation behind the move; perhaps yesterday’s sharp move was more a reflection of positioning with market participants caught out.

That is echoed by Peter Schaffrik at RBC:

Our interpretation is that Draghi gave a more subtle message than perhaps reflected in the market reaction.

Overall, Draghi was much more confident that the ECB was on course to return euro area inflation to its objective. However, our conclusion that the speech was less hawkish than the market reaction suggests is based on his twin calls for ‘persistence’ and ‘prudence’ in the future path of policy; persistence emphasising the need to retain the ECB’s accommodative policy stance to ensure inflation becomes ‘durable and self-sustaining’ and prudence the need to be cautious in withdrawing stimulus as the economy recovers.