Protocols: the situation is growing hot

ECB came to a unanimous opinion regarding the need for further decrease of deposit rate
The market response to the terrorist attacks that took place in Paris on Friday evening turned out to have unstable and insignificant effect. The crash of stock indexes was accompanied with strengthening of safe assets. Various inside information regarding the outcome of the ECB's meeting on December 3 attracted investors' attention. American data in both reports turned out as weak, but the balance remains: dollar must grow since rate increase is at hand; however, dollar is declining because the market has practically worked off this factor. Judging from statements made by European officials, ECB came to a unanimous opinion regarding the need for further decrease of deposit rate. Discussions are held not only regarding amounts; moreover, even reduction by more than 0.1% is being discussed. The issue of QE expansion is considered as the most debatable, since the increase of state treasury bills comes in conflict both with the law and politics, and it is difficult for now to find new assets. It is under consideration whether to include even the issuance of large municipal bonds into the program. The German Council of Economic Advisers has published a survey, which demands that ECB completely stop QE program or, at least, reduce its volumes since low rates are negative for banks and insurance companies.

Protocol one. At the same time, Draghi communicated to the markets that inflation expectations have been reduced due to low oil prices and delayed effect of strong (recently) euro rate, and therefore, ECB, on December 3, will consider new coordination measures. However, those very expectations are reliably held on maximums near the ECB target level, and what "strong euro rate" can there be if the main currency is confidently moving to this year's minimum? ECB's stress tests showed that 9 more banks are short of capital in the amount of 1.74 bln euros (according to the Saturday reports).

Protocol two. France: the global terrorism remains an active factor of influence on economy, politics, and prices. Investors are in panic and are abandoning euros in expectations for expanding spread of yield of the US treasury bonds and German bonds. It is clear now that the terrorist attacks in France will lead, at least, to the fall of European GDP due to reduction of tourist revenue, which gives ECB another cause for expansion of stimulus measures. The terrorist attacks have caused differences among the Eurozone countries regarding acceptance of refugees (Poland has refused to accept people within quotas), and possible early elections of French President threaten another crisis regarding the demise of Eurozone. Another alarm: resignation of the Portuguese government, and although the country's ratings have kept high, the recurrence of the Greek situation has scared off investors.

Disclosure of FRS meeting protocols as of October 28 is viewed as the key point of the week. The accompanying statement showed two basic points: absence of mention of the "global risks" of decline and anticipatory policy with indication of direct mentioning of the possible rare increase in December. The neutral tone of the protocols is the most likely. The positive of the absence of risks has already been used, and the fears of external events are at their minimum. America just needs to have at least one-off increase of the rate in order to eliminate the doubts of FRS efficiency after 7 years of too soft regulation.

The main points of the protocols that need to be paid attention to:

  • Has the negative influence of the strong dollar rate been noted?
  • Have any fears regarding the global risks remained?
  • Do FRS members have any doubts regarding rate increase in 2015?
  • Updated (and additional) FRS reference points for rate increase particularly for the December 16 meeting.

In general, the situation is very frail, and FRS and ECB officials realize it. Strong labor market by the results of October, situations on the Chinese financial markets, and stabilization of prices for raw materials (not only for oil but also for metals) makes FRS face the choice - why doing something if the situation allows not to do anything and get the desired result? The market pays so much attention to this situation that any decision can cause an unreasonably strong response - something like the Asian stress after yuan's decline by 2%. For retail players, it means readiness for dramatic growth of dollar in the first days and weeks, if ECB expands stimulus measures and/or reduces its deposit rate, and FRS will increase its rate two weeks after that. And then EUR/USD parity will not even be the end of fall.

The following of the additional events should be noted:

  1. The Japanese currency has had a really hard time: at first, the events that took place in Paris resulted in strengthening of yen; however, soon the dynamics reversed and closed the upward gap. That also reflects the unfavorable state of the Japanese economy: By the data for the third quarter, its GDP turned out as negative which can cause the Bank of Japan to expand its stimulus measures.
  2. The Chinese situation proves the approach of the second wave of panic: the report regarding decline in new loans for October means dramatic slowing down of the economy. China will continue to support its stock markets until yuan is included into the basket of IMF reserve currencies on November 30; however, we will face the second fall of the Asian stock market sector.
  3. Treasuries are going up since investors are fleeing to the zone of the safest securities. Australian bonds have also gone up, which affected the decline of demand for Asian shares. A massive refusal from risky assets and sale of company shares is underway along with transition of capital to dollar and gold. The growth of Swiss franc, which added 0.28% against euro is an obvious confirmation of that.

USD/JPY: mark 125.30 will be the next target - it is the maximum of August 8, 2015. Japanese retail investors continue to have appetite for buying dollars while yen is trying to become stronger. In any case, the pair retains its bullish tone while prices are above level 121.75.

EUR/USD: Important intraday support: 1.0650, strong mid-term 1.0630-1.06. In case of penetration further, market-makers have protection in the area 1.0520/1.0500, and presently, large players protect the approach to this area. However, the market can come out of this state of decline unexpectedly and dramatically. The main obstacle in case of upward movement: level 1.7500. Reference points: 1.0790-1.0820. In case of consolidation above the indicated level, the bearish tendency will collapse prior to 1.1000-1.1050.

Author: Lachlan Patel,
ForexChief Currency strategist