ECB and FRS: revision of lessons learned

The issue of the rate will obviously not be dealt with at the FRS meeting because of the dramatic increase of the US dollar exchange rate - almost by 2% after December 16

Last week, stock and raw materials markets still operated due to the new perspectives of the expansion of the ECB's stimulus measures and those of the Bank of Japan, as well as due to the progress in numerous negotiations of the oil producing countries. US dollar grew stronger against euro, yen, and franc; however, just the opposite, a tendency for dollar decrease was observed in the pairs with commodity currencies. This week can be divided into two parts: the first one is related to market expectations, and the second - to austere reality of facts.

The vectors of the American and European monetary policy keep on moving in opposite directions. Draghi's new threats to correct the ECB's monetary policy at the meeting on March 10 do not intimidate anyone; it is clear that his abilities are limited by the mandate, the absence of consensus, and the growth of economy. The fall of euro by over 100 points began after the phrase regarding the decline of oil quotes and added some drive after mentioning the problems with refugees, pressure on prices, low inflation, as well as with regard to unclear "circumstances that changed". Super-Mario traditionally avoided giving detailed answers to questions threatening with many instruments at the ECB's disposal and confirmed that the ECB members decided not to make public discussions of the range of possible March measures.

Now, ECB measures will completely depend on oil prices, i.e. we will need oil prices growth to the level of USD 42 for a barrel (or more) until March 10 and the absence of secondary effects in the form of the fall of the general inflation and/or salaries. A decrease of the deposit rate by at least 10 bps is likely as those additional stimulus measures; that possibility was indicated in the Protocol of the Meeting on December 3. We cannot leave out more aggressive rate decrease in case of the fall of base inflation and salaries either.

The extension of QE program in Europe for half a year with reinvestmenting will add 680 bln euros, which makes around two thirds of the total volume of asset purchase. The extension of the asset purchase program is quite doubtful. The yield of German banks fell because of Draghi's speech since investors hope that new purchases on the part of the Central Bank allow to resell the newly purchased assets. Today, ECB's verbal interventions have more influence on the market than possible real actions, and therefore, all the inside information for the press has already been figured out and will be delivered in batches in case of the least growth of EUR/USD. Until the ECB's March meeting, euro will, most likely, move steadily, and we should be worry only in case of the publication of information regarding inflation and statements made by key officials.

The issue of the rate will obviously not be dealt with at the FRS meeting because of the dramatic increase of the US dollar exchange rate (almost by 2% after December 16). That strengthening after 11% growth in the previous year has already been slowing down the economic growth and put some pressure on inflation, which is chronically below the target values. However, the possible comments, as it is common, can add volatility to the market. In general, the meeting is expected to be "transitional" even without Yellen's press-conference. Unexpected addenda to the regular accompanying text may influence the market the most. The statement rhetoric may become tougher now due to partial change of the voting composition of FRS: 3 hawks (Bullards, Mester, George) and one dove (Rosengren) joined the Committee.

The meeting of the Bank of Japan on January 29 will, ultimately, have to give assessment to the growing pressure on the monetary policy on the part of the government. In case of the change of inflation forecasts, the expansion of QE program is possible since 2/3 of the Japanese bond market will be open for purchases. Adoption of such an important decision at this meeting is unlikely; however, Abe's new intervention can change the situation. Reaching the BoJ's 2% target in 2016 is unlikely, there is a chance of revision of the inflation target, which also increases the chances for easing of the monetary policy. If inflation forecasts are not revised downwards, a dramatic fall of USD/JPY below 115 will be expected. Adoption of measures for the expansion of QE will cause the growth of the pair far beyond 120 level.

The following of the other news should be mentioned:

  1. According to the Bank of America, large investors have pulled out USD 24 bln from equity funds within the first weeks of January since the present-day markets are going down closely following oil prices. The highest decline was with regard to the shares of the developing market (USD 2.3 bln) - the strongest outflow of funds within 19 weeks. Due to security issues, investors rushed to state bonds since S&P declined by 7.2% from the beginning of the year, and Dow Jones Index has lost almost 8% despite the recent rally. Nevertheless, the analysts believe that the worst is still ahead.
  2. The Central Bank of China made new cash injections via open-market operations. On Tuesday, 440 bln yuan injections (about USD 67.1) into the country's financial system were conducted by way of operations for a term of 28 days and with the yield of 2.6% (360 bln yuan (USD 54.9 bln) and shorter 7-day injections with the yield of 2.25% in the amount of 80 bln yuan (USD 12.2 bln). Also, short-term loans in the amount of 400 bln yuan were offered - traditional attempts to add liquidity before the Chinese New Year.
  3. Bloomberg resumed publications of the data regarding international reserves owned by central banks except gold reserves. The information as of 08.01.2016 was shocking: the total volume of the global reserves was USD 11,032 trn, i.e. the reduction of the reserve volume was USD 1 trn. Such a huge decline by 8.31% from the maximum of USD 12.032 (01.08.2014) took place just in 17 months since the continuous growth of reserves went on for about 70 years. This fact obviously shows that the lengthy economic recession turned into a major depression. The global elimination of reserves has been underway, and there are no grounds for cessation of this process so far. A question arises: who purchased (with cash) that amount of state bonds worth of 1 trn that the banks have been selling for the last 17 months worldwide? And what discount did they get for buying those bonds? And if there was no discount then why? If securities worth of such huge amount of money disappeared from bank balance sheets worldwide then where are those bonds now? There is no answer for now.
  4. On Thursday, we will be waiting for the German index of consumer prices - the forecast is bad, euro can produce a strong downward spike; moreover, a huge batch of US statistics is expected on that day. On Friday, preliminary data regarding the change of US GDP volume will be published - as it was predicted, the data will fall from 2.0% to 0.8%. That will be a blow for those who expect good statistics; that will be the case even if the data will fit the forecast.

EUR/USD: mid-term neutral zone: 1.0970-1.1020, trade above/below will speak about risk priority. Special attention should be drawn to mark 1.0850 - its confident penetration will send euro downward to the level of intraday support 1.0800. Mid-term resistances: 1.0835/1.0880/1.0910/1.0950, resistances: 1.0770/1.0760/1.0735/1.0710. Market makers have formed a strong Put range 1.0800-1.0700, it will be very difficult to penetrate it downward; however, we cannot rule out such a variant. The general sentiment of the pair is still negative; therefore, we need to follow the fundamental background closely.

Author: Navsher Bartash,
ForexChief Currency strategist