March: ECB’s painful month?

As you know, the Euro has been massively under pressure since the ECB’s May meeting last year and decreased from 1.40 to a low of 1.11 before edging back to 1.14. In my article The Euro Strength and The ECB’s options, I explained the ‘Euro strength story’ (July 2012 – May 2014) by the following three factors:

  • Narrowing peripheral-core spreads (After Draghi’s ‘Whatever it takes’ and OMT introduction)
  • Divergence between the ECB and the Fed’s balance sheet total assets
  • Current Account back into positive territories

During this ‘prosperous’ period, nothing was able to stop the Euro despite poor fundamentals (i.e. flat growth, high unemployment rate and declining inflation). Then, Draghi’s promise ‘the Council is comfortable with acting in June’ completely broke the upside trend and the market has been totally relying on the ECB’s balance sheet expansion plan. It is clear now that EZ policymakers’ goal is to see the central bank’s balance sheet expend by 1.14tr Euros within the next 18 months and reach June 2012 levels (approximately 3.1tr Euros). As you can see it on the graph below (EURUSD monthly chart), the market got really excited about this news and traders and investors have completely switch to a bearish view when it comes to EURUSD (and EURGBP). We saw that Bulge Bracket banks reviewed their EURUSD forecasts for 2015. Sell-side research predicts a EURUSD between 0.90 and 1.00 within the next 6 to 12 months. Moreover, if we have a quick look at the last CFTC’s Commitments of Traders report, ‘net speculative’ positions were approximately -186,000 in the week ending February 17, and are closely approaching June 2012 low of -215,000.

Screen Shot 02-23-15 at 12.44 AM

(Source: Oanda, CoT)

If you ask me where I see EURUSD in the long term, there is no doubt that my answer is ‘South’. With the Fed considering starting its monetary policy tightening cycle (June meeting for a first 25bps shift probably), monetary policy divergence will weigh on the currency pair in the LT and parity looks like a reasonable level to me. In addition, Grexit contagion effect to ‘scarier’ countries such as Spain could also trigger another episode of peripheral-core yield spread divergence and therefore add more selling pressure on the single currency.

However, I think that traders and investors should be careful at the moment. Over the past two weeks, volatility has dropped in the market and EURUSD has been trading within a tight 180-range (1.1270 – 1.1450). Based on the last discussions I had, some of the traders were clearly waiting for a breakout ahead of the Greek deal, therefore the 1.1270 support was carefully watched on Friday (this is the reason why I put my take profit slightly above at 1.1300, see article Pocketful of Miracles). However, the Euro looks resilient based on current market conditions and I have to admit that I see potential Euro strength in the month coming ahead. As you can see it below, EURUSD reached a 11-year low at the end of last month at 1.11 before coming back to 1.14. The Fibonacci retracements were built based on October 200 low of 0.8230 and July 2008 high of 1.6040 range. Unless contagion risk spreads to other EZ countries (i.e. higher core-peripheral risk), the bullish trend could last for a month or two (based on previous bull consolidation after sharp sell-off).

Screen Shot 02-23-15 at 12.50 AM

(Source: FXCM)

The ECB bond buying program: Ambitious plan, disappointing results?

We are aware now that the ECB has announced a round of measures in order to counter the deflationary cycle (inflation rate of -0.6% in January) and of course support investment and consumption, the two key contributors of the 19-nation economy. The last one was of course the January announcement of additional purchases (combined monthly asset purchases of 60bn Euros from March to September 2016). This programs involves private assets such as covered bonds (safe form of debt issued by banks), ABS and public debt (bonds of national government and European institutions). However, unlike the Fed, the ECB will have to seek them in the secondary market; in other words, find the banks that will sell them these bonds. And Draghi’s (and Co.) problem here is that the ECB may face unwilling sellers. As some of you know, banks’ treasury desks usually buy short-term bonds and use government debt as a liquidity buffer: regulators require banks to hold high-quality liquid assets – HQLAs – against future cash outflows in periods of market stress. As some of you may know, most bonds issued by banks are excluded as they may prove illiquid during a financial crisis; however, the eligibility requirements imposed on government bonds look loose. Therefore, this implies that that government bonds currently represent a considerable portion of bank assets.

In the European Union, there are two new ratios:

  • Liquidity Coverage Ratio LCR, requiring banks to hold a stock of liquid assets for an amount covering the net liquidity outflows which might be experienced, under stressed condition, over the following 30 days,
  • Net Stable Funding Ratio (NFSR), which requires that the amount of available stable funding (i.e. portion of capital and liabilities expected to be reliable over a one-year time horizon) should be at least equal to the required amount of stable funding or the matching assets (i.e. illiquid assets which cannot be easily turned into cash over the following 12 months).

These two ratios were enacted through a Capital Requirements Directive (CDR4) and Regulation (CRR) issued in June 2013. Based on the Basel 3 documents, liquid assets in the LCR should mainly consists of:

  • Cash
  • Central bank reserves (including required reserves)
  • Marketable securities representing claims on or guaranteed by sovereign, central banks, PSEs, BIS, IMF, the ECB and European Community, or multilateral development banks
  • Bonds issued by non-financial firms and covered bonds with a rating at least equal to AA, subject to a 15% haircut and a 40% concentration limit

The two questions now that comes to my mind are:

  1. Who will sell those bonds to the ECB?
  2. Suppose the ECB offers good prices (i.e. good realized PnL for bond trading desks), what will traders do with this new cash with a deposit rate now at -0.2%?

Disappointing ECB could lead to Euro strength…

To conclude, I think there is potential risk that the ECB disappoints the market in March based on their purchases as the central bank won’t find the liquidity in the market. In my opinion, this scenario could play in favor of the single currency. My point is that we may see a bull consolidation before reaching the parity level that everyone seems to be talking about. The next couple of resistances to watch on the topside would be at 1.1530 and 1.1680.

Don’t fall in love with your US Dollar positions…

As you know, the Fed stepped back from the market by announcing the end of the QE3 era last Wednesday. However, another major central bank, the BoJ, took over by increasing [eventually] the amount of its current bond-buying program by 10tr Yen to 80tr Yen (and tripled its purchases of ETFs to 3tr Yen). You saw the consequences since then, with USDJPY that tested a new 7-year high at 114.00, up almost 5 figures in two business days. The Nikkei closed above the 16,400 level on Friday (16,413.76), but didn’t participate to the overnight development as Japanese market were closed due to Culture ‘holiday’ Day.

To sum up, the Fed is done with QE [for the moment], however we have two other big players – ECB and BoJ – which are trying to do whatever it takes to keep pushing asset prices higher. As a reminder, the ECB plans to increase its total balance sheet by 1tr+ EUR within the next couple of years to come (now is it possible? That’s a different story. See article ECB dilemma: Whatever it can…).

It looks to me that the chart to watch now is the total big-4-central-bank balance sheet. As you can see it on the chart below, 10.5tr USD were injected into the market since the GFC; and from what I hear and read, we are far from done…

CBs

(Source: Barclays)

One thing that makes me uncomfortable at the moment is the sharp appreciation of the US Dollar against all the currencies. I believe even though US policymakers are conscious the USD will strengthen in the long term, however I think that they are looking for a slow and gradual increase.

In its last minutes, the Fed expressed its concerns about the rising dollar (too fast indeed is what they meant) and its negative effect on inflation and US exporters. The market has to accept that, otherwise the topic will come back on the table each time (minutes, meeting, semi-annual testimony…).

Quick update on the Euro

The single currency broke its strong support at 1.2500 against the greenback (which represents the 76.4% retracement of the 1.2040 – 1.3991 interval) and the pair is now trading at a 2-year [and 2-month] low, down 11% over the past six months. There are rumours (ECB Source) that the Fed launched currency war telling the ECB not to push it too fat (concerning its exchange rate). It tells you that the next and final retracement traders will look at is the 1.2040 low reached on July 20 2012.

EUr03Nov

(Source: Reuters)

FX positioning

I am still comfortable on being short EURGBP, targeting the 0.7750 retracement (entry level 0.8000, stop loss decreased to 0.8000). Watch the ECB and BoE meetings this Thursday.

I would like to add another position on today’s update: short AUDNZD at current levels (1.1270), with a target at 1.1140 at first and a stop loss above 1.1360. I know that the late inflation figures in NZ (which came in lower than expected at 1% YoY vs 1.3% consensus) will weigh on RBNZ officials to consider getting back in the tightening cycle, but I am comfortable with short the pair at the high of the range as you can see it on the chart.

AUDNZD03Nov(Source: Reuters)

Quick update on FX positioning

The US dollar remains strong against all the currencies since yesterday, erasing little by little its post-minutes losses. EURUSD is back to 1.2660, the trend looks bearish and I would set my short term target at 1.2600. A bit late for bears (above 1.2750 was a perfect level to short the pair again), but there is little room for the downside. I’d play short EUR/GBP at 0.7900; a GBP strength relative to the Euro is inevitable, long-term bears just have to be patient for the 0.7500 retracement.

AUDUSD is back to 0.8700 (beginning of the week’s level), despite strong employment reports yesterday in Australia, with full time employment up to 21.6K in September (from 14.3 the previous month). I read that global growth worries will continue to weigh on the Aussie (with always the same story with China’s) slowdown, and the market clearly sees an Aussie trading at 80 cents against the greenback sometime in mid-2015. Next support on the downside stands at 0.8650 (we’ll see if it holds this time).

On the Yen side, I clearly think the bearish USDJPY momentum is not over yet and the JPY should continue to strengthen in the short until we see the big buyers-on-dips. The next support on the downside stands at 107.14, which corresponds to the lower band of the Bollinger Band (20,2x), followed by the psychological 107.

Bonus Chart before US opens:

S&P500-Oct10(1)

(Source: Reuters)

Quick update on the Euro

This morning, EZ August flash inflation came in at 0.3% YoY and confirmed falling trend (from 0.4% in July). The ECB meets next week (September 4) and the market is pricing some action: talks of corridor rates cut, updates on the ABS program…

My advice is ‘stay short EURUSD’ for those who got in already, or wait for a bounce back above the 1.3200 level for entering a short position. Large offers are seen at 1.3200 – 1.3250 (combined with huge expiries, 4bn Euros of vanilla option according to Reuters). Though the first support stands at 1.3100 where we might see a pause, my MT target remains at 1.3000. After German retail sales printed much lower than expected at -1.4% MoM in July (vs. 0.1% consensus), Italian quarterly unemployment rate rose to 12.6% in July (vs 12.3% expected) and preliminary inflation (EU Norm) entered into a negative territory, printing at -0.2% YoY and joining Greece, Spain and Portugal in recording annual consumer-price declines.

Peripheral yields picked up a bit, with the 10-year Italian and Spanish yields trading at 2.44% and 2.24% respectively, up from Wednesday’s low of 2.36% and 2.09%.

My view goes for a corridor rate cut in order to optimize the T-LTROs (first starting on Sept 18). ABS purchases sound a bit premature…

EURUSD-29-Aug(1)

(Source: Reuters)

Another way to play the Euro at the moment would be against GBP as I believe the market has overreacted to the some data disappointments and a slightly dovish QIR (Quarterly Inflation Report) back on August 13th. Good resistance level is at 0.7960/5, therefore going short EURGBP at around that level with a first target at 0.7880 (stop loss above 0.8020) could be a good strategy. Bank of England is also meeting next week but I expect it to be a non-event.

Quick Overall update…

This week has started with limited risk appetite as situations in Iraq and Ukraine both remain intense. US yields still struggle to take off in the middle of this QE Taper environment (10-year is trading below the 2.60% level), while Gold and Silver both continue to soar and are now trading above 1,300 and 21.00 levels respectively. The US Dollar remains offered against most of the G10 / EM currencies; as you can see it on the chart below, the USD index continues its bearish momentum and is now trading at 80.23 between its lower Bollinger Bands (20, 2.0) and its 200-day MA.

usdiNDEX

(Source: Reuters)

Dollar Bloc: Low vols sustain demand for Dollar Bloc currencies and especially the Canadian Dollar. Since its high of 1.1278 on March, USDCAD has entered into a bearish momentum as the Loonie continues to benefit from higher than expected CPI figures. As a reminder, annual inflation came in at 2.3% in May (vs 2.0% consensus) and stands now above the BoC 2-percent target. USDCAD broke its 200-day (1.0783) last week and visited its 5-month low at 1.0710 earlier this morning. The next support on the downside stands at the psychological 1.0700, followed by 1.0650 (Jan 7).

Yen: Low US yields in addition to a quite Japanese overnight session add pressure on USDJPY, still trading below 102.00. The pair has been stuck within a 70-pip range for the past couple of weeks, trading above its 200-day MA (101.65) and below its 100-day MA (102.20). The pair’s vols stands at their lowest level; the 1-month ATM volatility decreased to 5.02% (from 10.2% in the beginning of February). USDJPY looks vulnerable and I would carefully watch the downside at the moment; a break of the 200 MA would push the pair back to its strong support at 100.75. On Friday, we will get an update on inflation and household spending figures in Japan; Core Nationwide CPI is expected to increase to 3.4% in May (up from 3.2% the previous month) and could continue to disappoint investors on the easing measures (no signs of urgency from BoJ policymakers).

Euro: I expect the single currency to come back under pressure in the medium term as it seems that the ECB is not done with easing. Final Inflation came in at 0.5% YoY in May a couple f weeks ago and flash EZ Mfg. PMI printed below expectations of 53.5 at 52.8 (French Mfg. PMI was miserable at 47.8). Traders will watch closely updates on Inflation (flash) and ECB figures (Private loans and Money Supply) next week on Monday. EURUSD is trading back above 1.3600; the next resistance zone is seen between 1.3660 (higher Bollinger Band) and 1.3670 (200-day SMA).

Sterling: After Carney’s hawkish comments at the Mansion House that the BoE will consider raising its Official Bank Rate (currently at a historical low of 0.5%) sooner that the market expects (which meant Q1 instead of Q2 previously), today’s testimony before the Treasury Select Committee sounded a bit dovish. BoE Governor said that the ‘exact timing’ if a rate increase will be ‘driven by the data’ and will be ‘limited and gradual’ based on the central bank’s estimation. The 2-year UK-US yield spread shifted lower to 41.1bps this morning (down 4bps), bringing Cable below the 1.7000 level. There has been a large build of long Sterling positions for the past few weeks based on monetary policy divergence (long GBPCHF, GBPJPY or short EURGBP are popular positions to hold at the moment), and the dovish stance of this morning may be another good opportunity to enter (buy on dips / sell on rally) for traders or investors.

Quick market update…

Geopolitical tensions in Iraq, with militants taking control of a strategic Shi’ite town – Tal Afar – located in the North of the country, continue to drive US yields lower. The US-year yield is down 7bps from Friday’s high of 2.644%, pushing USDJPY below the 102.00 level. The next resistance on the pair stands at 101.70, followed by 101.55 (last week’s low). Last week, Bank of Japan decided to keep its monetary policy steady and seemed quite confident that the economy will meet its 2–percent inflation target without additional stimulus. Vols on USDJPY are now back to historical levels (for instance 1W ATM is trading at 5.47%), and the pair seems now stuck in the 100.75 – 103.00 range as we reported last time in our Update on Japan.
The Nikkei index dropped below the 15,000 (closing at 14,933) as geopolitical tensions kept investors on edge, a red session that continues now in Europe with the DAX down 1.6% since last week all-time-high of 10,033.74.

The British pound hit a high of 1.7010 against the greenback this morning before it started to be sold. A support zone is seen between 1.6900 and 1.6920 where we could potentially find new ‘buyers on dips’. In the UK, there are the Financial Policy Committee at the Bank of England and inflation figures tomorrow, BoE minutes on Wednesday and Retail sales on Thursday. On the US side, the Fed meets this week and there is little doubt on a update on its monetary policy; it will continue its Taper ‘auto-pilot’ strategy by cutting purchases by another $10bn bringing down the APP to $35bn.

The Euro remains week against the major crosses, trading below 138.00 against the Yen, at 1.2175 against the Swiss Franc and at 0.7980 against Sterling. I wouldn’t play the single currency for the moment especially after the sharp fluctuations we saw in the last couple of weeks; perhaps I will try to be long EURGBP (intraday position) based on a technical view (RSI is showing an oversold signal at 21) with a ST target at 0.7990.

Watch the 2-year yield spreads!

Yesterday evening, while most of the people were watching the World Cup first game’s kick-off, BoE Governor Carney and UK’s Chancellor of the Exchequer George Osborne both gave a speech at the Mansion House. The topic on the table was their concerns about the UK housing market as a rate hike would stress mortgage debt and therefore threaten the recovery. Until now, investors and traders were pricing in a rate increase somewhere in Q2 next year; however, Carney surprised the market by stating the Official Bank rate hike ‘could happen sooner than markets currently expect’. It immediately shifted the UK rate curve higher, with the 2-year now trading at a 3-year high of 0.852%. If we have a look at the chart below, we can see that the UK-US 2-year spread (in red) rose 10bps sending Cable (in yellow) to the roof. After it nearly reached its strong psychological resistance at 1.7000 on May 6, the British pound had entered into a bearish momentum against the greenback until it test its support at 1.6680 (mid-April lows) a few times. Despite strong UK fundamentals, the market is more concerned about the rate ‘neutrality’ debate and which central bank will consider starting raising its benchmark rate early next year.

Cable-2Y

(Source: Reuters)

However, this week’s strong employment data in addition to Carney’s hawkish speech played in favour of the pound which hit its psychological 1.7000 resistance against the US Dollar yesterday. We reached our target on EURGBP at 0.8000 based on my previous article (Some overnight developments), which has also been driven by the 2-year UK-EU yield spread (in orange, reversed scale RHS) as you can see it below.

EG-2Y

(Source: Reuters)

With the FOMC meeting next week, I assume that the volatility will remain low and especially in the FX market. Carry trade currencies (especially the Kiwi) should continue to outperform in this market. We saw yesterday that a currency that will remain under pressure will be the Swedish Krona (SEK) after the CPI came in at -0.20% YoY in May. If deflation continues to stagnate at around 0%, the Riksbank will have to intervene later this year but cutting its benchmark by another 25bps (it currently stands at 25bps), therefore impacting the currency.