FX5: ECB December Deja Vu, Not Even Close

Friday March 11: Five-things the markets are talking about

ECB’s Draghi did not disappoint yesterday, he delivered a full slate of monetary policy easing in his continuing quest to spark inflation in the eurozone.

The decision drove heightened volatility across all asset classes. The initial reaction saw equities surge and the 19-member ‘single’ currency plunge to a new five and a half week low (€1.0825).

However President Draghi’s assertion that there would be “no further easing” stemmed equity gains and reversed the trade in the EUR to new monthly highs (€1.1217). Even spreads tightened – benchmark 10-year yields rose across the board in Europe and the U.S.

1. Markets continue to process ECB moves with an eye on Fed

Yesterday’s decision by the ECB to cut all three of its key rates and expand their QE bond buying program by +€20b to +€80b a month is bold.

The use of non-bank investment-grade corporate bonds for the buying program will vastly expand the universe of debt the ECB can choose from. Previously, it looked liked they would be running into supply constraints.

Slashing bank-funding costs by unveiling a new four-year TLTRO loan program, which could carry interest rates as low as the deposit rate (now cut to -0.4%), will be good for the ‘real’ economy. Technically, banks will be subsidized to lend and this should also help the battered Euro financial stocks.

The ECB insists that it’s not out of ammunition, but do concede that they cannot go as “negative” as they would like without negative consequences for banks.

Many would view the decision as the perfect post G20-easing policy; the stimulus will support domestic demand in the eurozone and will be expected to return inflation towards its target. The extra Draghi jawboning will keep the currency impact somewhat muted, hence the U-turn.

Stocks and bonds are beginning to unwind yesterday’s losses as traders/investors warm to the ECB’s policy measures. Credit markets, the main beneficiaries of the program, are extending Thursday’s rally, while the EUR (€1.1110) has weakened ahead of the New York open.

The focus will now turn to Federal Open Market Committee (FOMC) next week with expectations of similarly cautious approach by Yellen and company in spite of continued run of solid job gains, some progress on inflation, and reduced volatility overseas.

2. Other Central Banks may need to react

The ECB’s aggressive move may require other central European banks to follow suit to avoid an unwanted firming of their own currencies. Unless central European banks are to lower their own interest rates to preserve their rate differentials versus the Eurozone, capital will flow in and their currencies would come under appreciation pressure – which would make eventually somewhat uncompetitive.

Thus far only the Hungarian Central Bank (MNB) has signaled clearly that it will reduce interest rates. The National Bank of Poland (NBP) has reluctantly acknowledged that rates may have to be lowered by another -25bps. The Czech National Bank (CNB) deems negative interest rates potentially dangerous at present.

3. Have oil prices bottomed out?

An IEA monthly report stats that oil prices might have “bottomed out” as there are clear signs that market forces are working their magic and higher-cost producers were cutting output.

Production from non-OPEC exporters is expected to decline by -750k barrels a day this year, or +150k barrels a day more than estimated last month.

Markets are also being supported by output losses in Iraq and Nigeria, and as Iran restores production more slowly than planned following the end of international sanctions, according to the report.

Commodity sensitive currencies (CAD, AUD and NOK) remain better bid heading into the stateside session.

4. Canadian employment numbers

Both the loonie and Canadian equities have quietly rebounded since bottoming out in January, but today’s employment number could be some of the best evidence this year to answer the question of whether this modest recovery in Canada’s has traction.

The CAD reached its highest level in four-months (C$1.3224) after the Bank of Canada (BoC) kept its benchmark interest rate unchanged earlier this week and said an economic recovery led by non-energy exports remains on track even after a sustained run of strength in the loonie.

Year-to-date, CAD has been the top performer in the developed world since Governor Poloz refrained from cutting interest rates in late January. The loonies rise has been aided mostly by the +42% rebound in crude prices from their 2016 low print eight-weeks ago.

Canadian monthly employment numbers tend to be rather volatile. The consensus view for this morning is that the Canadian economy will have added about +8,600 jobs in February and the unemployment rate to remain unchanged at +7.2%.

5. PBoC strengthens Yuan fix to 2016 highs

The People’s Bank of China (PBoC) set the Yuan mid-point at ¥ 6.4905 vs. ¥6.5129 prior; the strongest setting since Dec 30 2015.

Analysts believe that the PBoC’s objective may be to support the exchange rate in defense against the crowded global ‘short-yuan’ trade in the wake of this week’s disappointing exports and trade data. They want to keep dealers and investors second-guessing. It’s also somewhat convenient for authorities to set a buffer into this weekend’s release of lending, industrial output, and retail sales figures.

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