Forex Flash: EUR/USD sustainable rally unlikely even on ECB's bazooka - Westpac

FXstreet.com (Barcelona) - EZ peripheral spreads have compressed in recent weeks, with Draghi's liquidity intervention threats being the trigger. However, as Westpac strategist Richard Franulovich notes, EURUSD's performance amid what is now another short-term EZ spread compression "is likely to resemble what occurred during the LTRO episode of Nov 2011-Mar 2012" he says.

The Westpac analyst notes the EURUSD sensitivity is stronger to long term 10yr peripheral bond spreads than short term 2yr peripheral spreads. Ergo, "given that any potential ECB intervention will be focussed exclusively on shorter term maturities EURUSD may ultimately not benefit as much" Richard adds.

Regressions also shows that EURUSD is more sensitive to core EU-US yield spreads than shorter term EZ peripheral spreads as well, Mr. Franulovich explains. "Going forward its not clear how core EZ-US yield spreads can turn sustainably in EUR's favour." The analyst points that only about 50% of a 25bp ECB easing is priced in for the ECB over the next few months and long lead indicators continue to point decisively toward material Eurozone growth underperformance vs the US.

Besides, "the OECD's leading indicators for June were released last week and they continue to tell a very sorry tale for EZ growth prospects relative to the US" the Westpac analyst notes.

Lastly, Richard Franulovich, note: "With longer term peripheral EZ spreads and core EZ-US yield spreads both more important for EURUSD direction than short term EZ peripheral spreads the currency will likely struggle to mount a sustainable rally even in the event that the ECB's "conditional bazooka" is activated."