Week in FX – Draghi’s ECB Goes All In

The European Central Bank (ECB) was always expected to be the main event of the past week. Capital markets had time aplenty to prepare to react to President Mario Draghi’s post-meeting press conference. Would the ECB stand and deliver? Would it implement a quantitative easing (QE) package and what are the details? Despite it not being a unanimous decision, Draghi and his fellow cohorts on the ECB’s Governing Council delivered more than what the market was expecting.

This is the new world order for central banks it seems: shock and awe. In the context of sustaining market volatility, it’s working. Surprise actions have come courtesy of a few other central banks including Denmark’s which twice slashed its overnight rates due to safe-haven demand, and the Bank of Canada which unexpectedly sliced its overnight interest rate by 0.25bps to safeguard against plummeting crude oil prices. Credit the Swiss National Bank for kicking off the latest round of the global currency devaluation game with its franc flash-crash last week. It’s natural for the market to continue to question if yesterday’s ECB announcement to pump more than €1 trillion into the struggling eurozone economy will be capable of taming low inflation and boosting the region’s fortunes. The answers to such questions must wait for another day.

The Unpredictable Draghi Had Few Options

With interest rates near zero and ample loans to banks failing to boost inflation as initially hoped, Draghi and his team were left with few options apart from buying securities in the public debt market. Thus, the ECB will purchase €60 billion of sovereign debt from eurozone member states every month until at least September 2016, expanding its balance sheet by €1.1 trillion. The bullish point for the market is that the program could go on longer until, as Draghi said, “we see a sustained adjustment in the path of inflation.” In a concession to German QE skeptics, both the ECB and member national central banks will buy bonds, and share the risk of default.

The ECB has succeeded in weakening the EUR even further (down another 2% to just above the €1.1200 handle) — a primary objective. The fact that the program is open-ended has satisfied the market for now, but the proof will be in the pudding. What is good for Europe is bad for the EUR, and what’s bad for Europe is good for the EUR. With the bull market seemingly showing signs of stress, euro bears can roar with confidence for the time being.

Event Risk Hopscotch

Before the markets get to see the trickle down effects of the ECB’s labor, various asset classes are expected to be fast and loose as event risks occur throughout the year. Other central banks’ actions, jobs and wage growth concerns in the U.S. and U.K., the upcoming U.K elections, geopolitical upheaval and a sluggish Chinese economy will all be felt. Central banks are forced to maintain easy monetary policies as inflation weakens worldwide, dragged lower by plunging crude oil prices. The International Monetary Fund cut its outlook for global growth this past week, lowering expected consumer-price gains in advanced economies to +1% for this year from +1.8%. That is 50% lower than most central banks view as delivering price stability. All of this will eventually put the Federal Reserve’s stance to the test and market expectations on the Fed’s timing for a rate hike. U.S. officials are starting to reassess their outlook for the economy as global weakness and disappointing U.S data come to the fore. In particular, consumer spending will press the Fed’s determination to raise interest rates this year.

The first three weeks of this calendar year have certainly been eventful and there’s still 11 months to go. Investors and dealers would be wise to be “fleet of foot” in order to profit from any market opportunities.

On Tap for Next Week

Next week does not appear to promise the same amount of market thrills and spills but one can never be sure in these uncertain times.

The Aussies will not be open for business on Monday and hence will not weigh in on Greece’s parliamentary election on January 25 and its outcome. The eurozone’s most-indebted member state will determine whether or not it will continue to abide by the terms of its austerity program to keep German financial aid flowing.

Other potential market-moving events include Germany’s Ifo Business Climate data on January 26, the U.S. Federal Open Market Committee will set its policy on January 28, and the Reserve Bank of New Zealand follows suit later on the same day.

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