Launch of QE or collapse of euro?

The sensation that QE was launched by EB in order to continue further funding of the American debt with European money is getting stronger
Today, the policy of ECB, as a financial regulator, is connected to inflation values. It seems that everyone knew about it before Draghi's speech; however, judging by the market response, it was nearly for the first time that everyone understood the real «horror» of this condition. The sensation that QE was launched by EB in order to continue further funding of the American debt with European money is getting stronger. Somehow, the European money-printing machine was not started in last January, when there were only hints of deflation, but only now, when inflation has been reduced almost to zero. Today, the market of American debt obligations remains unattractive. Nevertheless, they are actively trying to persuade us that FRS has nothing to do with it, and that euro needs QE for taming inflation and for consumer stimulation.

There is no inflation without the final consumer. And if there is no consumer, there will be no production, and no raw materials and no energy resources will be needed. And it is not quite understandable, why, in this situation, money needs to be pumped into banks, where, in the best case, it will be invested in derivatives, and in the worst case - will get stolen in the form of cash. Listening to Draghi at the ECB last meeting, it was not possible to understand the clear reasons of such tardy regulator's actions, and the main thing is - does Europe really need this money? Last year stress-tests, in general, confirmed the stability of European banking system. Pumping new money into the system creates the problem of further distribution of assets; that is something not all banks want to deal with.

Active consumption declines due to demography - the average European grows older, and, therefore, does not accumulate money on deposit, invests it in insurances, target savings and pensions, takes loans for current large expenditures. Inflation will still be very low or even negative for a long time. Rates will have to remain low for many months. Europe will follow the FRS path again - the growth of rates will begin only after the end of QE, which means that ECB's present optimism is, to put it mildly, false.

We can see only three structural reasons of such dramatic decrease of euro rate:

  1. Net outflows from the market of instruments are abnormally high. Even if there were an influx of foreign investments to Eurozone, that would not stop this process at all;
  2. Disinvestment of instruments with fixed yield is accelerating, since ECB is planning to take the major part of bonds from foreign holders;
  3. The share of European bonds with negative yield is growing dangerously quickly. Now, around 40% of German, Finnish, Dutch, and Austrian bonds went into minus, and Belgium and France have around 30% of such papers.

The ECB policy is defined quite rigidly in one thing: only investment-attractive securities are subject to purchase, i.e. Greek bonds are not included in this process. Except perhaps Greece will pay off SMP bonds (July/August), than, provide it follows the other conditions, they can be included in the purchase program.

ECB has already allocated 100 billion euro to Greece and, presently, funding of the Greek economy constitutes 68% of its GDP (the highest Eurozone value). ECB is ready to continue financing but only in case of an active process of economic reforms. That means Greece will not have any chances to receive aid just for a song. They say that Cipras had a plan but it failed. Creditors remained unconvinced and did not yield to Greek blackmail. QE will move further; Greeks will keep on tightening their belts and will ask, ask, and ask.

Within the nearest 4-6 months, ECB will purchase all long-term Eurozone state bonds within the voiced limits ; that is why they will have to be expanded to, at least, 50% (theoretically, to 75%). Even taking into account that the major part of the negative regarding euro has been used by the markets, the perspective is hopeless.

The publication of NFP satisfied investors - this fact was followed by such results that it caused a large-scale purchase of US dollar on the whole market against all main opponents. Tightening of conditions for receiving unemployment benefits produces its results: reduction of welfare payments causes reduction of unemployment. Employers create more jobs with low salaries and the share of workers with low qualification continues to grow.

At the same time, no one was concerned with the fact that the revision of information for the last two months went downwards (which increased the current difference and stirred up the market), and the average salary showed, in general, slowing down. It is possible that FRS statements (on behalf of Lacker and Williams) persuading the world that the weak growth of American salaries was not an obstacle to rate growth and that the middle of this year was a great time for opening the «tightening» season, possibly, made additional contribution to the stabilization of dollar. It is possible that as early as at its March meeting, FRS will remove the word «patient» from its protocol, since even dramatic strengthening of dollar rate can force postponing rate increase by one meeting.

EUR/USD keeps on hovering in the zone of 11-year minimums. According to CFTC information, speculators reduced the volume of net short euro position again, but are active increasing short yen position. No serious news is planned for this week. Most likely, bullish sentiments regarding dollar caused by Friday NFP will be fully implemented within the previous ranges in the result of low-level trade. The glimpse of the nearest perspective shows support for euro at least on 1.0750-1.0600. However, on the way to parity, there are no serious obstacles yet, either.

Author: Navsher Bartash,
ForexChief Currency strategist