The European Central Bank's rate-hiking cycle is unlikely to be as long as markets expect. Unlike in 2022, the ECB isn't starting from deeply negative rates, reducing the need for an aggressive "catch-up" cycle. Risks are skewed towards fewer hikes than the 70-75 basis points currently priced by the market.

Contrary to typical FX reactions, hawkish ECB policy amid an energy shock would be profoundly negative for growth. Any rate hikes would compound the economic damage from higher energy prices, making the Euro more vulnerable.

J.P. Morgan's systematic models now rank the Euro as the worst-performing currency across 27 liquid peers. While factors like carry and valuation have been weak, the recent underperformance of European equities versus the U.S. was the "missing piece" that solidified the quantitative bearish case, aligning it with the macro view.

Any strength in the Euro from a hawkish European Central Bank is unlikely to last. The Eurozone's weak fundamentals—lagging growth, poor equity returns versus the US, and energy price vulnerability—mean that higher interest rates would further stifle the economy, making any rate-driven rally unsustainable and positioning the Euro as a funding currency.

A world of persistent inflation and hawkish central banks creates a prime environment for carry trades, even with moderating growth. Within the G10, currencies of energy exporters with high yields, like the Australian Dollar and Norwegian Krone, are particularly attractive. Their carry advantage over the US dollar is at its highest level in nearly a decade.

Markets pricing in ECB rate hikes after an energy shock is flawed. Higher energy prices are a negative growth impulse for Europe, hurting terms of trade and consumer spending. Hiking rates would only worsen the downturn, making European cyclicals and the Euro vulnerable regardless of policy.

ECB President Lagarde's statement that disinflation is over is likely a backward-looking comment on the progress from 10% inflation. However, the ECB’s own forward-looking forecasts project inflation will fall below its 2% target, suggesting that future rate cuts are more likely than the confident public rhetoric implies.

A hawkish ECB will likely cause the Swedish Krona (SEK) to underperform. Sweden's significant disinflation problem means the Riksbank cannot match the ECB's rate hikes. This policy divergence, evident in the widening Euro-SEK rate spread, creates a strong case for SEK underperformance, especially against the Euro.

Unlike the US Fed, the European Central Bank is expected to raise interest rates in response to the energy shock. This is because its single mandate focuses purely on inflation, and Europe historically experiences stronger 'second-round effects' where energy prices lead to broader wage increases.