ECB Easing – Not the Kiss of Death for Euro
Daily FX Market Roundup 03.10.16
By now everyone knows that the European Central Bank went above and beyond expectations and in response, the euro soared and European stocks fell. Not exactly the reaction the ECB may have hoped for. Many investors and economists believed that aggressive easing by the central bank would mean the kiss of death for the euro and now they are scratching their heads wondering why the more the ECB lowers interest rates, the stronger the euro. EUR/USD soared nearly 4 cents or 400 pips from its lows today which was the strongest one day move since the last deposit rate cut in December.
Had the ECB announced a little less and spaced out the moves taken today across different meetings while at the same time signaling that more action could be taken at future meetings, EUR/USD would have probably crashed. But the missing element today was forward guidance. The ECB pulled out all the stops and told the market that they don’t “anticipate more rate cuts.” In other words they’re done. While they could always introduce new measures if conditions warrant it, they are telling us that for now, they don’t see the need for any more stimulus. So for at least the next 2 to 3 months, there will be no immediate expectations for more action from the central bank. Considering that the market was short euros ahead of the rate decision, their shift to a quasi-neutral monetary policy stance after easing triggered a wave of short covering. We saw that in December and we’re seeing it again today. It can also be argued that the market is impressed by all of these measures and they expect the Eurozone economy to benefit significantly from today’s actions (hence the renewed demand for euros), but given how ineffective the actions were in December we doubt that today’s reaction reflects optimism especially with equities are falling.
The European Central Bank is clearly growing desperate. For the second time in 3 months Mario Draghi unleashed an aggressive combination of monetary stimulus. Here are the 6 main actions announced today, each powerful in their own right:
1. Main Refinancing Rate Cut to 0% from 0.05%
2. Deposit Rate Cut to -0.4% from -0.3%
3. QE Increased to 80B Euros Per Month from 60B
4. Introduces New 4 Year TLTROs
5. Expanded Asset Purchases to Include Corporate Bonds
6. Lowers 2016 and 2017 GDP and Inflation Forecasts
Unfortunately investors are disappointed that the ECB thinks that they have done enough. They are disappointed by the small deposit rate cut, the failure to extend the end date of asset purchases and the lack of a tiered rate system but most importantly they are worried that the central bank has run out of ammunition and have chosen instead to “overwhelmingly agree” to throw everything into the kitchen sink at once. Today’s actions reflect the depth of their concerns about the domestic and global economy – while the euro may reach as high as 1.14, each cent rise makes us wonder how much more the Eurozone economy can handle. The ECB may have taken big steps to stimulate the economy but a rising currency restricts economic activity especially for a region so heavily dependent on exports.
The ECB monetary policy announced triggered widespread volatility in currencies. The U.S. dollar plunged against the euro, British pound, Japanese Yen and Swiss Franc but soared versus the Canadian and Australian dollars. NZD/USD saw very little action before and after the rate decision. The rally in the British pound and Swiss Franc are understandable – both currencies moved higher in tandem with the euro and after today’s strong moves, we sense that a correction is likely. U.K. trade numbers are scheduled for release tomorrow and a larger trade deficit is anticipated. While the trade numbers are important, risk appetite and the market’s demand for euros and dollars will play a larger role in the direction of GBP/USD.
The more interesting question is how the ECB’s decision affects the Fed’s thinking. Theoretically, Fed policy is completely independent of actions taken in other parts of the world. In reality however, the steps the ECB takes affects the global markets which impacts the U.S. economy. Aside from the big move in the euro, which doesn’t directly affect the U.S., the rest of the markets are relatively stable. More stimulus from the ECB makes it easier for the Fed to maintain a hawkish bias and remain committed to raising interest rates again this year. As indicated by today’s jobless claims report, the U.S. labor market remains strong with claims falling to a fresh 5 month low.
Despite the modest decline in oil and gains in gold and copper, the Canadian and Australian dollars traded sharply lower against the greenback. The retracement in these commodity currencies suggests that investors are worried that the Bank of Canada and Reserve Bank of Australia are deluding themselves with their bright economic outlooks. Canadian employment numbers are scheduled for release tomorrow and despite the BoC’s optimism, the sharp drop in the employment component of IVEY PMI points to a softer release. The New Zealand dollar on the other hand held onto its gains with no follow through selling after the Reserve Bank’s surprise rate reduction. Although its 2.25% yield appears extremely attractive on the day of the ECB rate cut, we believe NZD should be trading lower given the RBNZ’s surprise move and xeasing bias.