Why EUR Negative Rates May Be More Important Than You Think

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Market Drivers for June 5 2014

AU Trade weaker but CNY PMI above 50 helps stabilize Aussie

EUR PMI Retail 49.9 vs. 51.9

Nikkei 0.08% Europe .05%

Oil $102/bbl

Gold $1243/oz.

Europe and Asia:

AUD Trade -0.12B vs. 0.40B

CNY PMI Svc. 50.7 vs. 51.4

EUR PMI Retail 49.9 vs. 51.2

GBP BoE Rate

North America:

EUR Bid Rate 7:45 AM

USD Weekly jobless 8:30 AM

EUR Presser 8:30 AM

CAD Ivey PMI 10:00AM

Currency markets were predictably quiet ahead of the ECB rate announcement due later today with EUR/USD continuing to trade within a tight range around the 1.3600 level. The eco calendar was relatively subdued although Aussie saw a small bit of action off the Australian Trade Balance release.

The Australian Trade numbers missed their mark printing at -0.12B vs. 0.4B eyed. This was the first trade deficit since the start of the year. Trade data has been in a steady decline for the past quarter with each successive month showing a smaller and smaller surplus until this months negative read. The deficit was driven by weaker export prices for coal, iron ore and gold.

The decline in Trade suggest that Australia’s terms of trade will decline in H1 of this year and provide less growth to national income than previously thought. Yesterday’s GDP numbers surprised to the upside, but much of the gain was due to seasonal adjustments and today’s trade data confirms the lackluster macroeconomic environment Down Under and indicates that some of the readings may be revised downward.

The Aussie initially dropped by 20 points in reaction to the news, but quickly found its footing after composite Chinese PMI showed a small improvement and more importantly a move above the 50 boom/bust line to 50.2. The market view is that as long as Chinese demand remains steady, so will the Aussie.

Today, however the focus will turn squarely to the ECB with the market eagerly anticipating the post announcement presser from President Draghi. The markets have already priced in the prospect of negative rates, so if the ECB surprises by doing nothing, the euro will likely spike in a knee jerk fashion, but given Mr. Draghi’s hint at the last meeting all signs point to a rate cut.

More importantly will be the presser that follows, as markets will try to get clarification on ECB’s future steps. In keeping with its conservative culture the ECB is unlikely to move aggressively on the policy front today and announce any major QE initiatives.Nevertheless it will be important to listen to Mr. Draghi’s rhetoric. There are two key issues that he may address. One he may state that the negative rates will remain for a considerable period of time, two he may hint that rates could be cut further at a later date – something that has already been hinted at in the financial press.

In both of those scenarios the euro could weaken more than the market currently anticipates. The conventional wisdom is that the rate cuts are fully prices into the EONIA curve and that only a major asset buying program could push the euro down. Much of that assumption rests on the idea that the negative rates will be a relatively short term gimmick. And in the past cases of OECD nations doing such policy that was indeed the result. However if the ECB commits to prolonged period of negative rates, such action could turn the euro into a funding currency and could keep it in long term downtrend not only against the dollar but against the high yielders as well.

Boris Schlossberg
Managing Director

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