Politics Not Fundamentals Guides the ECB

Thursday December 8: Five things the markets are talking about

Can Draghi afford to rock the boat today given what’s happened in Italy and what’s going on with the banks? The case for the ECB leaving policy unchanged centers around politics.

ECB officials will decide the fate of their €1.7T bond-buying program that expires in March in a few hours. With investors expecting at least a six-month extension, any move to scale back the program could cause large selling in the Euro debt market and certainly spill over into the U.S treasury market.

Ahead of the ECB announcement (07:45 EST) and Draghi’s press conference (08:30 EST) the single currency is trading atop of its three-week high (€1.8000). With investors currently very short the currency pair, there is an outside risk possibility that the EUR has the stamina to trade a tad higher, mostly on profit taking, towards the psychological €1.0850-65 level where the market is expecting a new wave of fresh EUR sellers to appear again.

There is a range of possible ways in which the ECB’s bond-buying program can change beyond March, which could be interpreted initially as been somewhat hawkish by investors – this market is not positioned for any hints of tapering. Investors need to listen carefully to Draghi’s press conference, Euro policy makers are expected to cushion any “hawkish” elements of its decision with dovish language and vice versa, which may mute the impact on the EUR.

1. Stock indices print record highs

Global equities are holding onto their recent gains overnight, supported by the possibility for more stimuli from the ECB and a firmer trend on Wall Street – on Wednesday, both the S&P 500 and Dow Jones Industrial Average closed at new record highs.

In Asia, risk appetite found further support when China reported upbeat trade figures with exports and imports both beating forecasts.

The resource-heavy Aussie ASX rallied +1.2%, as did MSCI’s broadest index of Asia-Pacific shares ex-Japan. Korea’s Kospi supported by electronics jumped +2%. Japan’s Nikkei has added + 1.45% despite a stronger yen, and a disappointing downward revision to its Q3 growth.

In Europe, equity indices are currently trading mixed across after opening sharply higher. Financials are weighing on the Stoxx 600, while commodity and mining stocks are underperforming and pressuring the FTSE 100.

U.S futures are set to open little changed.

Indices: Stoxx50 +0.3% at 3,148, FTSE -0.1% at 6,898, DAX +0.3% at 11,016, CAC-40 +0.1% at 4,698, IBEX-35 +0.6% at 9,015, FTSE MIB +0.3% at 18,192, SMI -0.2% at 7,914, S&P 500 Futures flat

2. Crude prices steady, commodities mixed

Oil prices are consolidating after slipping this week on doubts that production cuts promised by OPEC and Russia would not be deep enough to end a supply overhang.

Brent futures are trading up +18c at +$53.22, while WTI light crude has added +17c to stand at +$49.95.

Data this week showing record high production in the producer group will continue to support dealer doubts until proven wrong.

In other commodities, spot gold has nudged a tad higher (+$1,174.60), while industrial metals, including iron ore and coking coal, continue to hold onto their recent hefty gains as Chinese demand drive steel prices to their highest levels in two-years.

3. Treasury/Bund spread should widen, but……

The gap between German and U.S. bond yields is expected to widen further as the ECB is unlikely to ease up on its QE program.

Currently, fixed income dealers are pricing in a market-friendly outcome from this morning’s ECB meet – squeezing the yields of eurozone debt, which in turn should widen the spread to the U.S. market, especially now that U.S dealers are beginning to price in two Fed hike by mid-year 2017.

The Tsy/Bund spread has ballooned from just under +170bps before the U.S. election (Nov. 9) to its highs of +210bps fuelled by the Trump reflation trade. The spread is currently hovering atop of +200bps.

With the ECB running out of euro product to buy, policy makers are expected to tweak their QE program as well. Alongside an extension, the ECB may announce that they wish to start buying bonds yielding less than the bank’s deposit rate (-0.4%). That would allow them to keep buying German debt at the current pace until Nov. 2017.

4. Currency consolidation ahead of policy announcement, Kiwi flies

With the ‘mighty’ dollar continuing to consolidate against the major pairs, it’s a tad softer across the board heading into today’s U.S session.

The markets focus is obviously on the ECB and what affect it will have on the single unit (€1.1800, a three-week high) after this morning rate announcement and Draghi’s press conference. Dealers note that if the ECB decided on QE extension, without any hint of tapering, the single unit is expected to weaken against the major pairs.

Elsewhere, USD/JPY is lower by -0.2% (¥113.35), while the pound (£1.2703) is again attempting to take a run towards this week’s highs north of £1.2750.

Overnight, the NZD ($0.7218, four week high) was the biggest gainer amongst the major currencies. RBNZ Governor Wheeler made it clear in a speech that the bank was probably done with cutting interest rates. Also aiding the Kiwi was the NZ Treasury half-year economic and fiscal update – GDP targets were raised, while the jobless rate forecast was cut.

5. Mixed Data from China and Japan

Although the quarter is the third straight of expansion for Japan, their final GDP for Q3 was revised lower on soft CAPEX (capital expenditure).

The annualized headline print was lowered to +1.3% from +2.3% and q/q to +0.3% from +0.5%, with CAPEX the most notable downward revised component at -0.4% vs. +0% prelim.

In China, its trade components were a surprise, notching increases in both imports and exports.

China’s Nov Trade Balance showed a smaller than expected surplus in both USD and CNY terms, but exports and import components top expectations in both formats.

USD exports y/y was +0.1% vs. -5.0%e, while imports were +6.7% vs. -1.9%e. In CNY terms, exports were +5.9% (an eight-month high) vs. -1.0%e and imports at a three-year high of +13.0% vs. +3.6%e.

China’s Stats Bureau was even more upbeat on 2017 trade conditions despite worries over Trump protectionism.

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