A policy focused on an early exit from negative rates would be very bullish for the euro. DB shows that FX is far more sensitive to front-end rather than back-end yields and that this sensitivity has dramatically increased after the 2008 financial crisis. The bank also shows that the effects of negative rates are highly non-linear, so that an early ECB hiking cycle will have a disproportionately positive impact on FX.
In contrast, a policy focused on a tapering of the ECB’s PSPP program would not be bullish for the euro. QE operates via signaling effects on the short-term rate path as well as by depressing term premia. If the ECB is able to keep the front-end anchored, a rise in term premia alone could have bearish implications for the EUR via reduced demand for European fixed income. Similar effects were observed around the Fed taper tantrum.
According to the interest market the first move on rates won’t appear at lest until late 2018. source: Bloomberg
Taking it all together, the bank re-iterates its bearish EUR/USD outlook. DB expects EUR/USD to reach and break parity by next year. Their expectations are conditional on the ECB first winding down QE rather than initiating an interest rate hiking cycle. DB forecasts would survive a “one off” rise to the deposit rate, provided it stays negative. If the ECB was to signal an exit different from the above, the EUR/USD view would change.”
Specifically, in the case of rate hikes, the EUR would likely strengthen more against G3 and GBP than against the continental periphery. FX-rate betas are generally higher in G4, and unlike Fed QE, ECB QE primarily resulted in portfolio outflows to the other G4 economies. The UK looks particularly vulnerable to a reversal of “Euroglut” flows. In the continental periphery, EUR/SEK has become most sensitive to ECB sequencing.