Rich euro, poor euro or how Draghi teased the market

Speculations regarding FRS rates help maintain the weak yen
As soon as markets hint at stability or decline, there come the threats of the new process under the name of "quantitative easing". After ECB's discussion of negative interest rate, bankers that consider themselves socially oriented made panicky purchases of shares hoping to enjoy a free lunch. Let's try to understand what has come out of it. This statements reflects the current point of view of the majority of ECB members. At the meeting on October 22, Germany did not have the right of vote, and that hardly affected the result but evidently added comfort to Draghi. His statements traditionally verge on violation of ECB mandate, the rights of Eurozone's northern countries and, as a rule, have a percentage of confident bluff.

In order to push euro down from the mountain, the first phrases were sufficient, and further, the gentle tone only supported its decline. Just during the time of this speech, the state security bills of Eurozone's countries with negative yield grew from 1.38 trn to 1.57 trn euros. And what happens if, by Draghi's words, the regulator will present "the complete menu of the monetary policy" will be difficult to imagine. As based on the last week's events, the following conclusions are evident:

  1. The current goal was to secure euro decline at any price.
  2. If at the first ECB meeting all the possible risks were announced, then the second describes the required measures and assign tasks to committees, and we should wait for real actions only at the third meeting.
  3. The situation, in general, will become clear before the ECB's December meeting; however, markets already include the reduction of deposit rate and expansion of QE program at the end of the year into the price of euro.
  4. If we have an ideal picture regarding the publication of data on the USA and China above forecasts, growth of stock markets and continuation of threats with regard to the increase of FRS rate in December, EUR/USD has a good chance to fall to parity before ECB meeting on December 3.
  5. An ideal situation is unlikely because the economies of the USA and China are slowing down actively, and FRS is simply under obligation to protect dollar rate.
  6. Usually, when case euro falls below 1.07-1.05, a dramatic flight of capital begins, which is especially painful for Eurozone's southern countries. Politicians will do everything in order to prevent it.
  7. Even if euro shows parity by December, ECB, most likely, will not risk taking additional measures, and that will result in a vertical growth of euro right after the meeting. Draghi obviously does not need this situation.

Let's note some more painful points:

  1. On Friday, China reduced its lending rate and deposit rate by 0.25 ppt, reserve ratio by 0.5 ppt, and eliminated its maximum bank deposit rate. That triggered growth on the market regarding gold and yen quotes. Monday data were mixed, however, in general, they was better than expected, although the internal composition of GDP confirms manipulations with statistics, and rate reduction is obviously speaking about problems. More real statistics can produce a negative impression; however, cheap money is already present on the market. We should expect the second wave of panic on stock markets in November - December.
  2. Speculations regarding FRS rates help maintain the weak yen, and that is why the Bank of Japan again delays another expansion of monetary and credit stimulation referring to difficulties on labor market.
  3. SNB keeps on being nervous when assessing the consequences of Euro-QE expansion, fearing the domino effect. The country's dependence on exports to Eurozone, aggressive credit policy, and serious weakening of euro against franc put pressure on the Swiss economy.
  4. Let's go back to Greece: the reforms that were conducted allow creditors to provide another aid to the country in the amount of 3 bln euros. In the nearest 2 months, the work regarding recapitalization of Greek banks and Greek debt will become more intense.
  5. IMF is ready to approve inclusion of the Chinese yuan to the reserve basket of currencies and put yuan on the same level with dollar, yen, euro, and pound. Yuan has been in compliance with technical criteria for a long time; the only thing that remains is the political decision. In any case, changes in the basket will come into force not earlier than in October 2016.
  6. The information regarding the amount of the US national debt of 18 trn US dollars is slowly turning into official data: the amount of obligations - debts, benefits, pensions are estimated as 20.7 trn US dollars, the assets of the government - over 3 trn US dollars, and the overall debt exceeds 62 trn US dollars. The US Ministry of Finance believes that the budget will run out of money on November 4. Several US state treasury bills auctions have been called off, and the raise of ceiling is expected in the nearest future.
  7. Serious analysts discuss the possibility of repetition of TWIST program regarding redemption of long-term bonds in exchange for short-term treasury bills. That will suppress the growth of long-term interest rates and will stimulate mortgage lending.
  8. Monday was noted for dollar decline against the background of extremely negative data on new home sales.
  9. A regular FRS meeting is starting today. We shouldn't expect dramatic statements; however, a new discussion of interest rate increase perspectives poses a real threat for dollar. Now, approximately 50% of dollar index is made by euro rate. Yellen is not really worried about weak euro; however, she is much concerned about the force of US dollar, moreover, dollar dynamics is more favorable with regard to other base currencies. Now, FRS has three times more difficulties securing its promise to raise rates as soon as during this year. In September, this decision had to be delayed due to strong dollar, and it is on the previous level today. Maintaining the rate will mean loss of trust; however, it can be always raised by insignificant 0.1 bps, and that topic will be closed for at least a couple of months.

Technical analysis. Regarding USD/JPY, it is recommended to retain short positions from level 121.30/40 with goals at 119.40 and stop not below 122.00. And regarding EUR/USD, levels 1.0890-1.9500 even in case of current prices growth are balanced. It is particularly from them that the continuation of adjustment based on weak US data, FRS dovelike rhetoric and/or in case of Eurozone's inflation growth to positive values will be very likely. In general, a wide flat 1.1107-1.0847 will be logical. In case of fixation above 1.1150, we can expect growth to 1.1300. In any case, we do not recommend to buy euro/dollar without serious fundamental reasons this week.

Author: Lachlan Patel,
ForexChief Currency strategist