Pressure Intensifies for ECB’s Draghi

Summer holidays? What summer holidays? It is near impossible to take your eyes off the trading screens, in doing so, one may misinterpret the next event or geopolitical risk that has been thrown at capital markets in the most unique of times. Market dynamics are shifting, albeit regional, political, and economical. For dealers and investors, that provides asset price movement and a host of trading opportunities among the varying asset classes — bonds, equities, forex and commodities.

Tension between Russia and the West, combined with the knock-on effect it’s having on European growth, continues to roil financial markets. European bourses are extending their declines while safe-haven government bonds continue to linger near their record price highs. The benchmark German 10-year bond yield has fallen to a record low this morning (+1.08%), while its two-year compatriot trades negatively — yields fall as prices rise. The current and future economic fallout of Western sanctions, along with the potential Russian retaliatory actions has capital markets continuing to trade risk-off. For investors, they will be looking for hints from European Central Bank (ECB) President Mario Draghi on the bank’s response if eurozone economic growth continues to sputter and disappoint.

The bigger picture for forex has been dominated by central banks’ low-rate monetary policies. To date, those restrictive policies have managed to handcuff investors to a low volatile and volume-trading environment, a scenario that brings with it limiting trading opportunities. This morning, the market will zero in on the latest policy announcements from the Bank of England (BoE) and the ECB.

BoE to Stand Pat

There is no pressure for BoE Governor Mark Carney to do anything. The market expects another unchanged monetary policy announcement from the Old Lady when its two-day Monetary Policy Committee (MPC) meeting concludes. For the U.K., its key economic data release this week was July’s service sector purchasing managers’ index on Tuesday. It managed to print its highest level for the year — 59.1 versus 57.7. Among those details, and what could be supporting a BoE tightening cycle later this year, is the indication of “capacity pressures” as the backlog of work rose at a “marked and accelerated pace.” The only possible change is in tone as stronger fundamental reports increase the scope for dissent among MPC members.

Few Expect the ECB to Act

With European inflation anchored close to zero, renowned weak growth, softer German manufacturing data and rising geopolitical concerns certainly makes for a depressing backdrop for Draghi’s highly anticipated press conference. The ECB is expected to remain on hold with rates and other policy actions later today. The ECB chief is likely to emphasize the long-term refinancing operation that will start in September, and the completion of the bank’s asset-quality review in October. With respect to inflation, he is likely to downplay the eurozone’s recent drop to +0.4% in July from +0.5% in June, while highlighting lower energy prices and higher core inflation. He is expected to reiterate the ECB’s commitment to implement further easing measures should the eurozone’s situation worsen in the second half of the year. The only possible surprise from the post-meeting press conference will be if Draghi does not make further “dovish” noises. His problem is that the ECB is almost out of ammo and vague promises will be punished.

Aussie Sinks on Poor Jobs Data

To date, Governor Glenn Stevens at the Reserve Bank of Australia (RBA) has been overtly critical of the high value of the AUD. Earlier this week, the RBA kept rates anchored at a 12-month low (+2.5%) despite mining investments cooling and a stubbornly strong Aussie. A percentage of the market was probably expecting more direct jawboning from Stevens, but he admitted that the outlook for the Australian economy looks challenging and refrained from talking the Aussie down from lofty heights. As it turns out, he didn’t need to thanks to a disappointing Australian employment report.

The AUD is straddling a two-month low (AUD$0.9270) after data showed the jobless rate rose to a 12-year high of +6.4% — the first time above that of the U.S. since 2007 — while employment changes were a slight net negative against an expected rise of +13k. Digging deeper, the full-time component gained +14.5k, however total hours worked fell for the first time in three months with a 14.8M decline. The participation rate rose to +64.8%, a four-month high. One mixed or contradictory data point does not initiate a trend; nevertheless, despite insufficient evidence for an RBA cut, it does up the ante for no rate hikes for the remainder of this year. The net gainer in a low-rate environment is the carry trade, and in particular, Antipodean currencies funded by cheap EURs (EUR/AUD and EUR/NZD). This has certainly been a coveted trade this year and it is also an overcrowded one. If U.S. yields do happen to climb those positions will get squeezed, especially if Draghi utters, “whatever it takes.”

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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