FX5: Draghi Faces New Policy Dilemma

Wednesday February 17: 5 Things The Markets Are Talking About

Some investors, traders and dealers continue to be at odds with the recent Russian/Middle-East oil deal. The overnight Asian session tried to disown the deal, while this morning’s Euro session seemed happy to look past concerns over global growth that sent shares and currencies lower in Asia.

This week’s equity rally was always going to be considered tenuous after the deal between top oil producers to merely keeps oil output flat this month while Iran refuses to reduce its “ramp-up” would have a minimal effect on crude prices. Are we about to witness an equity rally “dead cat” bounce?

1. Asian Equities retreat as China resumes weakening Yuan

In the Asia session, risk selling resurfaced (AUD was as low as A$0.7085, NZD near N$0.6550, and JPY outright down from session highs below ¥113.70, while April Gold rallied over $10 to $1,210) after the People’s Bank of China (PBoC) cuts its Yuan fix for the second straight day in what was also the biggest decline in the fix since Jan 7th. (PBoC sets yuan mid-point at ¥ 6.5237 vs. ¥6.5130).

NDRC (National Development and Reform Commission) spokesperson Zhao said China could keep the Yuan exchange rate and employment stable despite downward economic pressure. Zhao added China economic fundamentals have not changed, even as the government looks to find jobs for those lost in steel and coal industries.

Ahead of tonight’s inflation data, NDRC official said the figures might be impacted by the rising vegetable prices. Also, China MOFCOM (China Ministry of Commerce) spokesperson Shen noted China was not experiencing capital flight and that there was no basis for continued Yuan devaluation. A too rapid devaluation would most likely accelerate capital outflows from the country.

European indices continue to show strength after Draghi on Monday stated that the central bank would not hesitate to act to boost euro-zone growth and inflation, hinting at the possibility of further easing measures next month.

Some technical strategist note that the Farrell Index (explained and calculated by Zerohedge) is at the lowest level since August 1993 which could suggest that investors are currently “more negative than at the worst of both the dot-com bubble fallout and the 2008 financial crisis.”

2. Venezuelan and Iraqi oil ministers try to sway Iran on output freeze

Iran’s OPEC envoy is reported as saying it is “illogical” for it to join the oil output freeze agreed by a Russian and Saudi Arabian-led group yesterday. He said Iran would continue to increase oil production until it reaches pre-sanction levels.

Venezuela’s oil minister is due to hold talks in Tehran today to broker a deal with Iran and Iraq. Iran has only just come back on line and restarted oil exports after sanctions were lifted. Do not expect any progress, but keep an eye on the wires. Iran’s planned +500k bpd production increase is to be seen in about a month’s time.

3. Can we expect more BoJ stimulus in March?

There is certainly extra chatter about the possibility of more stimulus coming from the Bank of Japan (BoJ) in March. Kuroda’s negative interest rate introduction in January had no impact (apart from the initial brief yen pressure to ¥121.50 on the announcement). You could say that Kuroda’s negative rate policy failed to manipulate the domestic currency.

Japan’s PM Abe adviser Honda indicated overnight that it’s possible that the BoJ may add to the stimulus during next month’s March meeting. He would also recommend a fiscal stimulus package of around ¥5T and also the postponement of the second round of sales tax increase until April 2019.

The LDP party official Yamamoto reiterated his call for more policy measures in response to market volatility, calling for coordination with U.S and China officials in a “trilateral” summit to be held as soon as possible.

4. Draghi Faces new policy dilemma

It’s not an easy slam-dunk to do “whatever it takes” for Draghi in March. The battering of European financial stocks is certainly putting an enormous amount of pressure on the ECB not to lower subzero interest rates.

Euro financial stocks have been hit hard, aside from capitalization concerns; negative rates erode their profits. The fear of further negative rates will only worsen the Euro’s financial equity rout.

How far can Draghi cut rates without driving away investors and customers from Europe’s battered banks? Never underestimate the influence of financial institutions no matter how far they have fallen. The president needs to stick to his guns and telegraph the whole process-no BoJ surprises. He needs a weaker EUR!

Expect March to be a busy month on the Central Bank Front (Fed, ECB and BoJ).

5. U.K Unemployment rate falls, wage growth barely moves

GBP (£1.4271) was soft in the early portion of this morning’s session with headwinds attributed to “Brexit” concerns and the dwindling prospects of near-term Bank of England (BoE) tightening.

U.K wage and employment data came in slightly better than expectations but average weekly earnings registered a 12-month (January jobless claims change: -14.8k vs. -3.0ke; weekly earnings (ex-bonus) 3M/Y: +2.0% vs. +1.8%e; weekly earnings registers a low at +1.9%).

According to Markit’s survey of U.K households this month only +46% of households expect a BoE rate hike within the next 12-months. This is down from +71% in November. This would suggest that a rate hike would come as a complete surprise to many households, certainly something that Governor does not want.

GBP/USD has since move into positive territory ahead of the NY morning open (£1.4330).

Now onto the Federal Reserve – They are again in the spotlight today, with the release of the minutes of the January policy meeting later this afternoon.

Forex heatmap

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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