EUR Sags as ECBs QE in No Legal Danger

The 19-member single unit has been given the green light to commence with its next leg lower outright after this morning’s headlines from the European Court of Justice (ECJ). Even though the initial headlines from the ECJ advocate-general’s ruling looks good for the European Central Bank (ECB), there remains unanswered questions on how the court rules objections raised earlier by Germany’s highest court on the controversial bond-buying program.

The key takeaway from the ECJ’s interim ruling is that unconventional measures from the ECB are legal provided they are adequately explained. It also permits the ECB to buy large quantities of eurozone sovereign debt to stabilize the EUR and the economy. ECB President Mario Draghi and his fellow policymakers can breathe a sigh of relief as they prepare for another round of stimulus measures. What shape that support will take is anyone’s guess, but giving the ECB the opportunity to implement quantitative easing (QE) gives the bank the room it needs to maneuver.

The ECJ ruling is a response to a lawsuit brought by German opponents for looser monetary policy claiming that the ECB’s Outright Monetary Transactions (OMT) program announced nearly three-years ago violates the European Union’s treaty. While the court’s opinion is non-binding, the judges usually follow the advocate-general’s ruling. A final decision is expected in four to six months.

ECB Must Have Discretion

According to Pedro Cruz Villalón, advocate-general to the court, “the ECB must have broad discretion when framing and implementing the E.U.’s monetary policy and the court must exercise a considerable degree of caution when reviewing the ECB’s activities.” The OMT program is suitable to lower interest rates, he said, and would not lead the ECB to take on that would necessarily vulnerable to insolvency. He added that the bank’s bond-buying activities need safeguards to prevent violations of the prohibition against the direct financing of governments. The opinion also suggests that the ECB should avoid buying bonds of a eurozone government when it is selling bonds in the market to prevent prices in the primary and secondary market from being completely blurred.

A negative opinion would have thrown the ECB’s next round of stimulus efforts into turmoil. The market is betting heavily that Draghi and company will introduce QE at the next ECB monetary policy meeting on January 22. Policymakers need to boost the eurozone economy and beat back the possibility of an extended period of deflation. The region’s disappointing December flash consumer-price index headline looks and feels like trending deflation. Eurozone policy is required to get ahead of any broad-based decline in prices. Worse than inflation, falling prices and delayed future consumption can have disastrous economic consequences, and it’s not something that a low- to no-growth region can sustain for long before slipping into a recession.

EUR Sags after ECJ Ruling

The 19-member single unit negative trend remains intact, at least until the ECB meets in a few weeks. Daily record lows are the new norm. Up until this morning’s session the EUR had been relatively well contained, waiting for the ECJ advocate-general’s opinion on the OMT program. Since the announcement, the EUR has been trading on the ECJ’s ruling. Short covering was in evidence early and managed to push the EUR to retest the psychological €1.1800 handle. The currency pair began to gather downward momentum after the ECJ said OMT was available with conditions attached. A plethora of market stop-losses were triggered in and around €1.1755. A confident momentum break below €1.1750 seems to be convincing many analysts that the next down-leg for the single unit is very much underway (€1.1728 was touched), with initial targets of €1.1700, and the decade low of €1.1640. The lack of option structures so late in the game could suggest that the EUR/USD decline has the potential to pick up pace. For 2015, there has been little EUR consolidation in this crowded trade and there have been limited opportunities to sell the EUR on rallies. The EUR directional trend has only been one way, and without any shakeout, be forewarned: bearish investors should always tread lightly at record lows.

World Bank Changes Forecasts

A report out of the World Bank overnight estimates that 2014 gross domestic product (GDP) grew by +2.6%, up from +2.5% in 2013, but below the +2.8% forecast only six month ago. Officials from the organization have also altered this year’s GDP target to +3.0% from +3.4%, and the 2016 target to +3.3% from 3.5%. The bank has noted that risks to slow recovery are skewed to the downside, and it also warned that global trade could very much weaken further if both the eurozone and Japan slip into recession. The ECB and Bank of Japan have yet to come to grips with deflationary problems. On China, the World Bank noted that growth is expected to slow below the psychological +7% within two years from 7.4% in 2014. Officials also managed to cut the world’s largest economy’s 2015 forecast to +7.1% from 7.5% and in 2016 to +7.0% from 7.4%. The U.S. was one of the few positives. American GDP for 2015 was raised to +3.2% from +3.0% and again affirmed in 2016 at +3.0%.

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