Waiting for the ECB (Part 2)

This morning was marked by the Mfg PMIs data in Europe and UK, and we saw that both German and UK ones came in lower than expected at 49.9 (vs 50.3 expected) and 51.6 (vs. 52.5 expected) respectively.

After a first disappointment in the T-LTRO allotments on September 18th (first tranche came in below 100bn Euros at €82.6bn), EZ Inflation (flash) edging down by 0.1% to 0.3% YoY in September (5-year low) [and a jobless rate steady at 11.5%, if this matters], and now German manufacturing PMI showing its first contractionary print in 15 months, I am curious to see what Draghi has up his sleeve for tomorrow.

German 10-year yield has been trading below the 1% level for the past week, and the 2-year yield of the EZ core countries are all trading below zero (Horizontal red line) now (see chart below).

CoreYield(Source: Reuters)

With the recent moves on the Euro (nobody seems to like the currency anymore), I don’t think that ECB officials are under pressure to deliver more measures (aka public QE, purchases of sovereign bonds). They will probably give further details on the ABS program and the quality of assets it accepts as collateral in exchange for its cheap loans. This, combine with a little bit of jawboning, should cap the Euro on the topside against the greenback.

As a reminder, the poor figure we saw for the first tranche of T-LTROs on September didn’t have much of an impact on the single currency (some analysts were predicting a little spike in that scenario). Moreover, there are a couple of events coming up this month for the ECB to consider for its purchase plan(s): hearings from the European Court of Justice against the OMT plan (starting Oct. 14) and the Asset Quality Review results (to be published at the end of the month Oct 25-26).

As I usually say, any bounce back to higher levels is seen as new opportunity to short the pair (either against the US Dollar or GBP). My next targets are set at 1.2500 and 0.7750; I wouldn’t be surprised if we see a EURUSD down to 1.2000 by the end of the year if the market keeps ‘rejecting’ the single currency (and have preference for the greenback).

In addition to US-EZ monetary policy divergence being the strongest reason of a weaker EUR/USD (ECB is about to expand its balance sheet by 1 trillion Euros while the Fed is ending its QE this month), growth divergence between the two economies could be another explanation. With politicians throwing sanctions to each other in response to the Ukrainian conflict, Q3 GDP in the Euro Zone looks ‘ugly’ (probably negative, which means that the EZ economy will enter into a triple dip recession if we define a recession by two consecutive quarters of negative or null growth).

Bloomberg reported that Russian gas supplies to Europe dropped 15% YoY in the third quarter (the most in 2 years) as natural gas transit through Ukraine plummeted 54% YoY (from 8.1bcm to 3.7bcm to give you an idea)… remember the chart I put in appendix. Some analysts are talking about a ‘Winter War’.

On the other side, the US are looking at a strong Q3 GDP after Q2 was revised higher to an annualized 4.6% QoQ (erasing the dismal 2.9% contraction in the first quarter). Economists estimate that the US economy will expand at an annualized rate of 3.0% in the July-August quarter.

Chart on EUR/USD:

EUR01Oct(Source: Reuters)

Appendix:

RussiaGas