Shine and misery of the ECB

Heroic Draghi’s speech in his press conference has succeeded in the euro rebound

This week has appeared to be the one of the most active since the beginning of the year. The ECB has undertaken all necessary measures which would have effect the next 2-3 months. The turmoil was not long but caused the drop of European assets more than by 11 per cent. Overall, the situation has calm down and the Federal Reserve is expected to undertake further steps. The decision to decline European interest rates has led not only to turmoil but déjà vu as it reminded situation before the financial crisis had started in 2008. It became apparent that before the ECB meeting commenced, Berlin Hyp bank issued 500 million euros of bonds with no coupon and priced to yield minus 0.162. It is evident that large investment (with anticipated losses) has been made into debt securities of the bank who is supported by the German government. It is also obvious that the bank who borrowed money attracted additional funding.

Swiss Re experts consider that about 20 per cent of all state bonds in the world have a negative profitability, while in Eurozone a percentage of such bonds amounts to almost 35% and the pension funds as well as insurance companies become the largest purchasers of the government bonds. Except interest rates the program outlines the following:

  • The volume of QE has been increased to €80 billion;
  • New program of specific bank refinancing for the next 4 years;
  • The forecast for GDP and inflation for 2016-17 has been decreased.

At present moment the ECB policy appears to be «the most radical program of financing» - the bank institution which is generally considered to be a bankrupt is able to finance banks that receive loans from Central bank in the course of the TLTRO II program (targeted longer-term refinancing operations). The borrowers, however, may receive money if they prove that they used attracted money for enlarging of lending opportunities for community and business.

Announced measures serve as the evidence of the weakness of the economy of the currency union. Facing lenient monetary policy Eurozone’s GDP shows «zero» growth, refinancing of the bank have not led to tangible results, ECB structural opportunities have been almost revealed to nil. The ECB cannot affect the changes in economy that caused deflation and slowing down of the economic growth: migration crisis, debt problems of the EU member states, oil prices fall, etc. However, the companies and people cannot be forced to receive new loans and the growth of consumption cannot be provided. The last (but not the least) measure that ECB may undertake is the start of direct lending to the households and private companies, namely purchase of the debts of above mention structures hold by the banks and purchase of state debts. The system of additional tax rates or investment preferences can be introduced, although the ECB is likely to undertake new measures if the current measures do not lead to positive results.

Heroic Draghi’s speech in his press conference has succeeded in the euro rebound while the Swiss National Bank had also contributed to the euro growth by interventions.

The ECB meeting has become history. Now there is a concern as to how Federal Reserve will perceive the ECB decision as the increasing number of euro stimuli enables FRS to keep harsh policy. The market players will be focused on the upcoming FOMC meeting. The FRS is unlikely to give rise to unpredictable behaviors in the market. The US retail and inflation data which will be released on 15-16 March can significantly affect the market expectations and Yellen’s rhetoric.

It is time to chase publications as the ECB representatives will attempt to mitigate the likely negative market reaction by additional comments. Although Draghi’s participation in EU summit on Thursday-Friday is as usual not announced, the comments are likely to appear.

There were some other remarkable events:

  1. Merkel’s defeat on the local elections serves an indicator of the German policy towards migrants. Mitigating of the German policy will positively affect Eurozone and euro in long-term perspective. Nevertheless, it is doubtful that the voters will force the Chancellor to change the direction of the migration policy.
  2. The interest rates cut by the New Zealand Reserve Bank has become unexpectable for the market, although experts predicted that it could happen in March meeting. The central bank also signaled at least one more rate cut to come in 2-3 months. As a consequence, NZD/USD has rebounded by 50%. Quarterly GDP reports are anticipated to be released this week.
  3. Under Bloomberg data trade shortfall between the UK and the EU is burdened by the lowest export level for more than last six years. This trend is unlikely to be favorable for upcoming Obama’s visit in April in bid to keep the UK in the EU.
  4. Chinese investment in Europe and the USA at the highest level - public and private companies have invested $23 billion in Europe, including Norway and Switzerland, and about $15 billion in the USA (the largest volume - in new York, California and Texas). The majority of funds was spent on financial transactions and property.
  5. As of March 11, the rising price of gold accounted for over 19% YTD - best result since 1974. Traded funds with gold collateral received a record inflow of $7.2 billion in February. Gold continues to be actively used for the diversification component of the state foreign exchange reserves, especially dollar. According to the IMF, world the world's Central Banks are net buyers of gold for eight consecutive years, and not always officially (among the largest - Russia, China and Kazakhstan), for the year 2015 was purchased nearly 590 tons of gold, official sources accounted for 14% of global annual demand.
  6. On Friday, the International energy Agency said that while the return of Iran to the oil market looks less bulky, so there are signs that prices for crude oil reached a minimum. Moreover, the possible effect of oil suppliers management volumes of production have further stabilize the market.

USD/JPY: Bank of Japan has left monetary policy unchanged, $90 billion of short-term investments have been released from negative interest rate for private investment funds. Main resistances 116.24/115.96/114.89/114.55, supports 113.82/112.20/111.87/110.96. «Bears» prevail in open volumes, while 113.00 is not enough for outbreak.

EUR/USD: major resistance 1.1320/1.1290/1.1220/1.1150 support 1.1100/1.1060/1.1030/1.0990. Open the volume are full of «bulls», but do not rule out a correction from current levels at least until 1.1060. Until Wednesday, most likely moving up.

Author: Alexander Ward,
ForexChief Currency strategist