FX Update: ECB checks euro advance. End of quarter for JPY.

FX Trading focus: ECB’s Lane caps euro advance. JPY and last day of Japan financial year. Next tests for Fed credibility.

The EURUSD advance was checked today in part by surprisingly dovish rhetoric from ECB Chief Economist Lane, who fretted the impact of soaring energy prices on growth prospects and argued that policy still needs to consider two-way risks from the ECB’s latest favourite word: “fragmentation”, which is the code word for uneven monetary policy transmission across the Euro zone due to perceived variation in credit strength by the various EU sovereigns that drove peripheral spreads wider together with the general sharp rise in EU yields in February, if failing to do so since the Russian invasion of Ukraine. After the latter, the strong sense of solidarity and large mutual EU debt issuance has made a strong impression and there has been no fragmentation since then even as yields have risen sharply again in recent weeks. Nonetheless, I have long considered it more likely and appropriate that the ECB ends up hiking rates for inflation credibility while still maintaining selective QE to avoid peripheral spreads blowing as they might if their QE ends. It is either that or a deepening commitment to a mutual fiscal foundation after the first steps in this direction were made in response to the pandemic, and now more impressively in the wake of the Russian invasion of Ukraine.

As discussed in the EURUSD chart below, this dovish blast from Lane and others at the ECB has turned the EURUSD rise in a very pivotal technical area, underlining its importance. The euro was under pressure broadly on today’s developments, as the war impacts clearly need to lift durable for the euro to realize its potential. EURGBP is at an interesting inflection points as well, having closed above its 200-day moving average (0.8470) yesterday and trying to follow through higher before a vicious reversal set in.

Chart: EURUSD
A mini-swarm of developments have seen the euro in steep retreat today after the sharp rally Tuesday that was built on the rather shaky foundation of hopes that Russia’s announcement of a cessation of operations in the Kyiv and other areas were a step in the direction toward détente. This hope has yet to pan out with any further developments, as natural gas prices remain elevated in EU and the latest leg lower in the euro around lunch-time in Europe today seemed triggered by Italy’s Prime Minister Draghi saying that Putin told him that conditions are not right for a cease-fire and that it is too early for a meeting with Ukrainian president Zelenskiy. Besides Chief Economist Lane’s dovish comments today, we also had the ECB’s Guindos out saying that he hasn’t seen many signs of rising wages yet and that he hopes inflation will peak in the next two to three months as part of the inflation shock is linked to temporary factors. The EURUSD action turned tail today after having bulled almost precisely to the late 2021 low at 1.1186. A weak close today underlines the importance of the 1.1125-1.1185 resistance zone and keeps the focus on the lower zone for now.