Ahead Of The ECB

  • European Central Bank December Meeting,
  • Thursday December 3rd, 1245GMT 
  • Current rate 0.05%, expected unchanged

October  ECB Meeting

The ECB’s October meeting delivered a heavy Dovish blow to the Euro as Mario Draghi and the governing council addressed the key weaknesses and threats jeopardizing the path to the ECB’s inflation target. Draghi cited the need for “thorough analysis” of the “strength and persistence of factors” weighing on inflation, among these the persistent weakness in emerging markets (particularly China) which is weighing on foreign demand and exports.

Further recorded threats to the inflation outlook were cited as the possibility of further price declines in Oil markets, though this was not included in the ECB’s “technical assumptions”, alongside the appreciation of the nominal effective exchange rate over the past several months (pre October). Draghi stated that “the degree of monetary policy accommodation will need to be re-examined at our December monetary policy meeting” and in the press conference which followed, markets were shocked to learn that the ECB was considering the potential not only for further QE but also for further reduction in interest rates.

Market reaction to the October ECB meeting saw EURUSD down just shy of 300 pips by midnight October 21st.

What’s Happened Since

Following the sharp sell off in initial response to the October ECB meeting EURUSD has since fallen another 500 pips lower as investor expectations have continued to mount in anticipation of further easing measures at Thursday’s meeting. Data since the last meeting has been mixed, though notably hasn’t materially weakened and indeed some areas have improved.

  • EuroZone October manufacturing and services PMI data both beat expectations
  • EuroZone unemployment declined to 10.8% from 10.9% previous.
  • EuroZone CPI improved to 0.1% from 0.% YoY in October, though MoM the 0.1% reading represented a decline from the previous 0.2% reading.
  • EuroZone Industrial Production contracted less than expected MoM at -0.3% vs -0.4% expected.and beat expectations YoY
  • EuroZone 3Q GDP undershot expectations at 0.3% vs 0.4% expected.
  • EuroZone ZEW economic sentiment fell sharply below expectations to print 28.3 vs 35.2 expected.

Alongside the data flow since the last meeting we have also had various comments on the wires from ECB members, most notably ECB chief Draghi who reiterated the seriousness of the threat to EuroZone inflation noting that “downside risks stemming from global growth and trade are clearly visible” and that “signs of a sustained turnaround in core inflation have somewhat weakened.” Draghi also commented on the ECB’s willingness to do “whatever necessary” in order to “raise inflation quickly”.

The minutes release of the October meeting also cast a further Dovish shadow revealing that the ECB was actually considering a potential increase in QE as early as October  but it was decided that waiting until the December meeting would avoid any premature actions on a possibly unduly gloomy outlook

The Global Picture

The various factors which have weighed so heavily upon the inflation outlook, not just of the ECB but of the vast majority of G10 central banks, continue to persist heading into the final weeks of the year.

The slowdown in emerging markets, led most notably by China, continues to cloud economic sentiment. Chinese data weakness which has been a common theme of 2015 was still heavily present these past months. October Imports were down nearly 20% YoY in October alongside a worsening Trade Balance, PPI data, and CPI which fell to -0.3% MoM in October vs -0.2% expected and 1.3% YoY vs 1.6% expected.

Oil prices, which appeared to have stabilised somewhat over the summer, have since resumed their decline with crude more than $5 lower than at the time of the ECB’s October meeting.

Of further note were the terrorist attacks in Paris in November which alongside the devastating loss of life has already cost more than 1 Billion Euros in lost tourism revenue and has the potential to incur further losses amidst expectations of further terrorist attacks and the occurrence of any such attacks.

Expectations For This Meeting

Investor expectations for this meeting are geared heavily towards significant action by the ECB. The ECB’s own declaration to review policy measures at this meeting,continued comments by ECB members and chairman in favour of further action and persistent weakness in global factors all point to further ECB easing. Expectations are such that to a very large extent, further action is already priced in, clearly visible in the sharply lower Euro.

With expectations for easing firmly in place, specific focus will be on the extent of policy adjustment at this meeting and the measures utilised.  A further ECB rate cut wil be more powerful than simply an increase and/or extension of QE whilst a dual approach of employing both measures will have the biggest impact. Draghi has a clear tendency to “over-deliver” with his policy adjustments, with investors clearly aware of this in the moves we have already seen.

The key policy areas to focus on for this meeting will be:

  • Deposit rate cut – How much and is it tiered? Markets are currently expecting a further 10bps reduction
  • The size of QE – By how much is QE to be increased?
  • The extension of QE – How far past September 2016 do the ECB intend QE to run?
  • The indicated openness of policy in 2016 – For example, the ECB cut cut rates but signal that rates are not yet at their lower band and thus signal scope for further easing in 2016.

Markets are expecting a further 0.10bps cut in the deposit rate and an increase & extension in QE. These expectations are what have driven EUR lower over the past month.  If the ECB wish to see EURUSD down to parity and below they are going to have to surpass expectations in their actions or at-least accompany their actions with language heavy enough to keep expectations of further action high enough to deter EUR shorts from any profit taking post-meeting. If the ECB simply deliver along the lines of consensus, investor scepticism could see a profit taking rally ensue and the ECB will be very mindful of this.

Trade Ideas

If the ECB deliver a rate cut with increase & extension in QE with clear room for further action next year this will weigh heavily on EUR. The BOJ are not expected to enact further easing this year, a dynamic which should lead EURJPY lower into year end.

Sell EURJPY

  • The break below the key 134 area base in EURJPY paves the way for a retest of the long term bullish trend line around 128 as first target and the 2015 lows just below.

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If the ECB, for whatever reason, fails to impress markets on Thursday then the ensuing investor skepticism is likely to see sharp profit taking on Thursday. A short squeeze in EURUSD presents a great opportunity to re-enter a at better levels ahead of the Decemeber FOMC where the Fed are set to raise rates, which will likely see EURUSD sharply lower at least in the short term.

Sell rallies in EURUSD

  • The Euro’s descent back down to 2015 lows has run our of momentum ahead of the ECB meeting with players awaiting a clear directional cue. A short squeeze back up into a retest of the broken 1.08 area lows ,and above it the broken bullish trend line, should cap the upside in EURUSD and as such look to sell into this area targeting a retest of 2015 lows by year end.

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