Research Team at Danske Bank, suggests that the risky assets have sold off hard and inflation expectations have collapsed recently despite a promise of more easing from the ECB, a cautious Fed and the Bank of Japan cutting rates into negative terrain. Key Quotes “The outcome of a crisis depends on fundamentals, confidence and the policy response. Fundamentals in the US in particular are relatively solid. But there are substantial risks to the global economy from the slowdown in EM and developing economies, which have driven 80% of global growth since 2008. Also, tail risks related to the US high-yield sector, oil USD pegs, EM corporate debt and the European banking sector are hurting sentiment, which will weigh on the global business cycle. Basically, the world is not yet facing a systemic crisis but risks are rising. There are mitigating factors versus previous crises but also concerns about declining market liquidity and challenges in EM. We believe there is an element of central bank fatigue. Central banks have been the only game in town to support the global economy and markets but there is only so much they can do. With interest rates at zero, central banks are primarily targeting the exchange rate, which is a zero-sum game and does not support the global economy. The ECB’s promise of more easing has only led to more EUR strength. USD/JPY is currently six figures below when the BoJ cut rates into negative territory, and 24 hours after the Riksbank cut rates further into negative territory, EUR/SEK is below where it was before. What could trigger a change in the current market sentiment? A global coordinated policy response, in our view. We have not yet reached a stage of market turmoil that would trigger a global coordinated policy response but watch out for the G20 Finance Ministers and Central Bank Governors meeting on 26/27 February in China. Hence, risky assets are set to continue to suffer near term. We believe there will be individual central bank policy responses, and we now expect the ECB to accompany a 10bp rate cut in March with the introduction of a two-tier deposit rate system and front-loaded QE. Specifically, we believe the ECB will introduce a maximum reserve requirement, where liquidity is placed at a rate above the deposit rate. In addition, we believe it will increase monthly purchases to EUR80bn between March-May 2016 and potentially longer, but the total QE size should be unchanged. We expect the ECB to react to collapsing inflation expectations rather than market stress. The two-tier deposit rate system should open the door for more rate cuts while at the same time reducing costs in the banking sector. We also expect the Fed to postpone the next Fed rate hike to September, as we believe the tighter financial conditions will result in a pause. As such, the Fed is likely to remain dovish in coming months but this is also already what markets are expecting with the first full 25bp Fed rate hike only being priced in by mid-2018. Near term, we expect EUR/USD to range trade as high risk aversion counterweighs relative interest rates. Medium term, we maintain our long-held view that EUR/USD will head substantially higher due to a range of fundamental factors.” For more information, read our latest forex news.