Euro-2015: QE or not QE?

The market does not need euro below 1.20 as well as dollar index above 90. Presently, EUR/USD still stays over 1.24 despite France's ratings going down, and prior to that Italy's ratings were going down (S&P)
Weak perspective of long-term price stability in combination with low rate of Eurozone economic growth requires ECB's final decision with regard to implementation of large-scale QE program. Reevaluation of the regulator's corresponding measures is planned as early as in the 1st quarter of 2015. Anyway, will the universal vitamin help Europe even if the results of three round treatment for the USA look quite disputable? "Easing" program invented by Ben Bernanke, i.e. buying of bonds by the state with the money made "from nothing" in order to decrease long-term interest rates is being actively advertised as a medicine for any structural problems in economy.

So, what positive things must a large-scale QE give to the crisis-stricken Europe:

  • Decrease of treasury bonds and average borrowing rate yields;
  • Movement of financial policy towards zero rates;
  • Accumulation of the critical volume of the national debt in the hands of a common financial regulator that is able to carry out active interventions in order to increase treasuries portfolio;
  • Decrease of national debt service cost for successful control of budget deficit. Even if ECB buys out only one quarter of French or Italian debt, the situation in those countries will improve very much.
Meanwhile, the problem of the extremely inflated internal balance arises, which represents a financial time bomb. More than a half of such balance must be money provided in the form of effective loans, but some kind of "excessive" bank reserves that must become deposits in case of economy strengthening and cause the growth of money aggregate M2, and, as the result, there will be an accelerated price growth. That logical chain can break any time in case of a new local crisis of the Greek type. That exactly contradiction is actively being used by euro QE opponents headed by Yens Wideman; however, even taking into consideration the usage of court mechanisms, their voice is too weak. Switzerland with its tendency to protect 1.2 level in EUR/CHF pair by way of currency interventions and support of its currency against G10 competitors can become another factor of euro stability.

With all its external effectiveness, QE macro model was not able to predict the current financial crisis. The operation of QE mechanism in case of investors' interest to purchases of euro securities can cause a stream of additional liquidity, but does not at all affect raw materials market, in particular - oil market. All the measures taken by ECB in the fight with low inflation have not produced any results; present decrease of inflation rate is stipulated by the fall of oil prices and can't be considered as a structural indicator.

Presently, Europe has been slightly late with the introduction of a large-scale QE; also, the declared balance level of 1 trn looks insufficient. The amount of the aggregate national debt of the EU countries is estimated at 9 trn euro, i.e. the declared size of asset purchase program (500 bln) will not exceed 5.5%. If ECB looks to, at least, the Bank of England, which purchased around 25% of its 2013 debt in order to stabilize the domestic market, then asset purchase must exceed 2-2.5 bln euro. Essentially, no one has any doubts regarding ECB's further expansion, and having marked balance level, the regulator has already launched QE mechanism, and the dates of official presentation don't have any meaning any more. Possibly that the amount of 500 bln is only the beginning of the series.

Situation on foreign exchange market: there are boundaries, and it is unprofitable for everyone to go over them. The market does not need euro below 1.20 as well as dollar index above 90. Presently, EUR/USD still stays over 1.24 despite France's ratings going down, and prior to that Italy's ratings were going down (S&P), which was already included into price as a response to failure to meet budget requirements. Dollar index bounced off its historical maximum. History shows that the lowest rate decrease occurs in the first 6 months after the beginning of heavy regulation. In any case, euro has already been oversold, and we should wait for adjustment to 1.28 level in the mid-term even taking into consideration the end of the year and the upcoming FOMC meeting. It is from those levels exactly that they can start selling it successfully.

Author: Navsher Bartash,
ForexChief Currency strategist