Proceed with Caution: It’s the ECB

It’s not unusual to see European markets steady after a sharp geopolitical gain, a gain that was sometimes confusing once given the ”he said, she said” details between Russia and Ukraine. Investors prudently seem to be adopting a wait-and-see approach ahead of key policy announcements today from the Bank of England (BoE) and the European Central Bank (ECB). The forex market has been severely restricted by near-uniform central bank monetary policies. Investors have had little choice but to succumb to the lack of volume and volatility supported by a low-rate environment. To experience sustainable volatility within this asset class, the market requires interest rate divergence, a phenomenon that is not in the cards for a considerable period of time to come according to interest rate pricing in the fixed-income markets.

Nevertheless, caution is the key word ahead of today’s ECB’s rate decision and press conference. The potential for ECB action has been on the rise ever since President Mario Draghi’s extra-dovish Jackson Hole speech late last month. Put simply, Draghi’s song and dance in Wyoming has the market in a tizzy. Traders are uncertain if the ECB will announce further easing measures — cut rates or introduce quantitative easing (QE) — to stimulate Europe’s already sluggish economic recovery, or wait and access the true impact of the credit programs announced in early summer. No matter what, eurozone policymakers need to act with authority to gain significant traction from any of their initiatives and the ECB, in particular, has a history to potentially disappoint. Due to the current positioning of the market (short EURs), any disappointment by Draghi and company will give way to a rapid short covering rally from the EUR (€1.3145).

Turbulent Times Ahead for Draghi’s ECB

The dollar has been gaining ground against the EUR and JPY as the Federal Reserve gets closer to raising interest rates, while the ECB and the Bank of Japan (BoJ) move toward loosening monetary policies. If there is no action from the ECB, then Draghi is likely to reaffirm the ECB’s commitment to further ‘potential action’ mostly on the back of downward revisions to its growth and inflation forecasts in his post-meeting press conference. It’s here that he may provide more details on potential asset-backed securities purchases. Doing so could uphold the view that the ECB is not falling short of expectations, and in a roundabout way, it would vindicate the various positions traders have taken. However, the ECB does have a track record of disappointing, but any disappointment could be short-lived ahead of tomorrow’s highly anticipated U.S. nonfarm payrolls release.

Japan’s Rosy Economic View in Bloom

Despite expectations of a more upbeat policy statement on Japan’s economic resilience from Governor Haruhiko Kuroda, the BoJ stuck to its familiar script and kept its overall assessment unchanged at its monetary policy meeting earlier this morning. Kuroda stated a strengthening greenback would not harm Japan’s economy as it “continues to recover moderately as a trend.” The BoJ took no chances and affirmed its assessment of exports, investment, employment, consumption, and inflation, while lowering its view on housing.

USD/JPY (¥104.90) is little changed and has failed to make any impact toward new yearly highs. It seems that the market would prefer to see what happens both in Europe and with tomorrow’s U.S. job numbers before committing to the dollar’s next move. The yen of late has come under pressure, not just on the difference in monetary policies, but on expectations that Japan’s government pension fund could take on a more aggressive investment plan. That would require a shift to more foreign assets and less of a reliance on domestic bonds. This course of action would also require some aggressive selling of yen to raise foreign cash to purchase foreign assets.

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This article is for general information purposes only. It is not investment advice or a solution to buy or sell securities. Opinions are the authors; not necessarily that of OANDA Corporation or any of its affiliates, subsidiaries, officers or directors. Leveraged trading is high risk and not suitable for all. You could lose all of your deposited funds.

Dean Popplewell

Dean Popplewell

Vice-President of Market Analysis at MarketPulse
Dean Popplewell has nearly two decades of experience trading currencies and fixed income instruments. He has a deep understanding of market fundamentals and the impact of global events on capital markets. He is respected among professional traders for his skilled analysis and career history as global head of trading for firms such as Scotia Capital and BMO Nesbitt Burns. Since joining OANDA in 2006, Dean has played an instrumental role in driving awareness of the forex market as an emerging asset class for retail investors, as well as providing expert counsel to a number of internal teams on how to best serve clients and industry stakeholders.
Dean Popplewell