Money Supply and Aggregates

Since GFC, central banks have injected trillions of dollars into the system in order to stimulate the economy and avoid a global liquidity crisis. We are now aware of how much important is the money supply for the financial markets as guru Bill ‘PIMCO’ Gross once wrote it in one of its Investment Outlook review: ‘There are bubbles everywhere…’ (Bond, equity or property).

However, even if we have a vague idea of the definition of ‘money supply’, which we would usually describe as the amount of money in the economy, let’s review the different ways to define ‘money’.

If we have a look at the ECB’s website for instance, we can find three different Euro area monetary aggregates:

  • M1: Narrow aggregate or ‘narrow money’ which takes into account the currency (notes and coins) in circulation in addition to overnight deposits (balances which can immediately be converted into currency or used for cash payments.
  • M2: Intermediate aggregate or ‘intermediate money’ comprises M1, deposits with an agreed maturity up to 2 years (non-transferable deposits which cannot be converted into currency before an agreed fixed term without penalty) and deposits redeemable at notice.
  • M3: Broad aggregate or ‘broad money’ comprises M1, M2, repurchase agreements, Money Market Fund (MMF) shares/units and debt securities up to 2 years.


 (Source: ECB website)

In the US, the Fed only publishes the M1 and M2 aggregates, as they announced they would cease publication of M3 in the spring of 2006:

  • M1: Total amount of cash/coins outside of the private banking system in addition to the amount of demand deposits, traveller’s checks and other checkable deposits.
  • M2 comprises M1 plus most saving accounts, money market accounts, retail MM mutual funds, and small denomination time deposits (CDs of under $100,000).

All eyes on ECB and EURUSD

EURUSD remains under pressure is now trading below its 200-day SMA (1.3640) at around 1.3600 after disappointing German employment and EZ data weighed on the single currency yesterday morning. ECB data showed that lending to households and firms in the Euro zone declined further in April by 1.8% from the same month one year after a contraction of 2.2% in March.
Moreover, the annual growth of M3 (money aggregate, definition here) declined strongly to stand at 0.8% (from 1.1% in March and vs. expectations of 1.1%) and stands well below the ECB’s target of 4.5% as you can see it on the graph below (which represents the historical path of M3 money aggregate in yellow and annual inflation in green since 2003).


(Source: Reuters)

Why is M3 important? If we have a look at one the ECB’s earliest Press Releases (December 1st, 1998) – The quantitative reference value for monetary growth – it stated that the Governing Council of the ECB agreed then on some details of the reference value:

  • ‘it will refer to the broad monetary aggregate M3’
  • ‘Governing Council decided to set the first reference value at 4.5%’

The graph above shows us that there is a relationship between inflation and M3 growth, therefore we could see still see a weak annual inflation next week on June 3rd (expected to come in at 0.7%). In addition, the HCIP (Harmonized Index of Consumer Prices, which enables international comparisons of inflation rates to be made between member states within the EU) of the core – ‘healthy’ – countries stand currently at very low levels. For instance, Germany HICP came in at 1.1% in April, up from 0.9% the previous month but down from 2.9% in August 2011. And in order to regain competitiveness, the peripheral ‘stressed’ countries are required to show a lower inflation than the core ones, which increase the risk of deflation (Spanish and Italian annual inflation stand at 0.3% and 0.6% respectively, while Greece and Portugal are already facing deflation).

ECB’s option at next meeting: All-in or non-event?

From now on, traders and investors will be focused on one of the most important events of the year: the ECB meeting on June 5th. After Draghi announced in his last press conference in Brussels that the ECB officials were ready to act at the next meeting, the question is now ‘what are the options?’ While a cut in the refi rate (10-15bps) is largely priced in by the market and will have little or no impact on both the Euro and the inflation rate, could it come with a cut in Deposit rate (which currently stands at 0%) and/or an asset-purchase program?

The effect of a negative deposit rate (10 bps cut), which means that ECB would charge banks for parking their money at the central bank rather than lending it, remains pretty much obscure and not the best option to encourage banks to lend more. It could potentially weigh on the single currency in the short term, which isn’t the ECB officials main objective (As a reminder, ECB’s Forum on Central Banking in Portugal, Draghi said: ‘What we need to be particularly watchful for at the moment is, in our view, the potential for a negative spiral to take hold between low inflation, falling inflation expectations and credit, in particular in stressed countries’).

Therefore, if we see an action, it will probably combine a refi rate cut with an unconventional measure according to some analysts. There are several monetary policy instruments that the ECB can apply in times of extraordinary market tensions, from a full-allotment of liquidity provision (fixed rate) to a longer-term liquidity provision (LTRO) or private/public QE.

Firstly, the fixed-rate full allotment, which allow stressed banks to access unlimited ECB liquidity at a fixed rate in return for collateral, will probably be extended (until this summer at least) and would leave the marginal lending facility, an overnight lending scheme that charges a premium interest rate, useless.

Second, we don’t think it is an appropriate time to launch a third LTRO as banks are still stuck with the first two repayments. Moreover, we saw previously that the LTRO has a positive impact on the Euro in the long-term. Liquidity will continue to drive sovereign yields lower and will tend to push the single currency at higher levels even though the Euro hasn’t been reacting to tightening spreads between periphery/core countries since Draghi’s press conference. Since July 2012, the 3-year spread Germany-Spain has tightened drastically and was one of main drivers of the Euro’s strength.

The third option is either a public or a private QE. A private quantitative easing would involve the purchases of private sectors assets, which could include asset-backed securities or bank bonds; rather than a public QE will include government bonds purchases (sovereign, ESM…). To me, these two options sound too much like a ‘whatever it takes to counter a strong Euro’, and we will repeat ourself by saying that ‘kill the Euro’ is not the core objective at the next meeting.

Quick analysis on EURUSD:

The pair found support slightly above 1.3580 and saw some bounce in Asia due to some short covering and saw technical ‘bull’ rebound after the RSI indicator was showing us an oversold signal. The resistance on the topside stands at 1.3641 (200-day SMA in blue), where we will start to see offers if the Euro continues to recover. The trend still looks a bit bearish at the moment, with 1.3520/40 as the next support area.


(Source: Reuters)

Time to play the crosses: long GBPCHF and GBPAUD?

The BoJ decided early this morning to keep its monetary policy unchanged by a unanimous vote and retain plan for a 60-70 trillion yen annual rise in the monetary base (JPY 270tr by the end of December 2014). Even though it was clearly expected by the market, Japanese policymakers’ lack of reaction continues to weigh on the equity market and the Yen. The Nikkei 225 index is now flirting with the 14,000 level (closed slightly above at 14,042) and is now down 14.40% since December’s high of 16,320; it is, as we have read in some reports, one of the biggest surprises this year with also persistent low yields in the US. Since the Fed decided to start its Taper in December last year ($10bn reduction each month), the 10-year US yield has constantly been trading lower and now sits at 2.53% (down from 3.04% on Jan 2nd), driving down the demand for long USDJPY positions. The graph below shows a daily chart on USDJPY over the past year As you can see it on the graph below, after the BoJ meeting, USDJPY broke its first support at 101.25 (200-day SMA) was sold to 100.80 before its started picking up again. We would stay out of it at the moment, even though we believe we should see USDJPY at higher levels in the coming days.


(Source: Reuters)

AUDJPY lost 3 figures since last week high of 96.10 and found support slightly above the psychological 93.00 level after it broke its 100-day SMA. The correction on AUDJPY came both from JPY strength and Aussie weakness as AUDUSD is now trading at a two-and-a-half week lows at 0.9220. The RBA minutes was released yesterday and the central bank said the board was considering to leave the current accommodative stance of policy for a considerable time. The trend looks bearish on the Aussie; as you can see it on the chart below, the next support on the downside for AUDUSD stands at 0.9170 (100-day SMA in blue), followed by 0.9050 (March 26 low).


(Source: Reuters)

In the UK, April retails sales smashed expectations and soared 1.3% MoM (vs 0.5% expected), pushing the British pound above the 1.6900 level (1.6920 was the high of the day). The BoE minutes showed that all nine members of the MPC are in favour of keeping the Official Bank rate at current levels (record low of 0.5%) and the QE program at 375bn GBP at the last meeting in May. However, the tone was pretty hawkish as some of the policymakers are wondering whether they should start raising rates sooner that later. The BoE is still seen as the first major central bank to start raising interest rates in early 2015. We reached our first target on EUR/GBP at 0.8100 (next support on the downside stands at 0.8030); at the moment, we would also look to play some crosses such as long GBPCHF or long GBPAUD with a short term target at 1.5200 and 1.8400 respectively.

The Fed is to release the minutes from its late April meeting in one hour. My guess is that nothing new will be announced and policymakers will continue the ZIRP policy (low interest rates) in order to support the markets and especially the equity market which is struggling to find some meaningfull direction since the beginning of the year.

Euro: Correction or Bear momentum?

After Yellen announced that the Fed will taper QE by another 10 billion dollars to $45bn monthly pace (largely priced in by the market, no effect on the dollar and US yields), it was Draghi’s comments last Thursday that triggered a reversal of the US dollar against the major currencies. During his press conference in Brussels, he said that the ECB officials were comfortable with acting in June if needed (in response to WSJ Brian Blackstone). The Euro, which surged to 1.3992 against the greenback after Governing Council of the ECB decided to keep interest rates steady (refi rate at 0.25%, deposit rate at 0.00% and marginal lending facility rate at 0.75%), fell dramatically after Draghi’s words. As you can see it on the chart below, it broke its 10-month uptrend on Friday (closing below it), its two supports at 1.3775 (April 30 low) and 1.3739 (100-day SMA) and seems on its way to test 1.3671 (April 4 low).


(Source: Reuters)

The single currency is now trading at 1.3710, down 60 pips from this morning’s high after Bundesbank comments ‘willing to cut rates if needed’ combined with disappointing German ZEW survey (economic sentiment printed at 33.1, well below expectations of 41.0). We believe that the bearish trend is ON now on the Euro, and our next target stands at 1.3670. Another good strategy would be to short EURGBP ahead of UK employment reports and the UK Quarterly inflation report this week. Economists expect the unemployment rate to decrease by another 0.1% to 6.8% in March (with a claimant counts change of -30K in April). Moreover, the divergence of monetary policy between a ‘hawkish’ BoE that is considering so start raising rates early next year and a ‘dovish’ ECB should act in favour of the British pound. The next resistance on the downside stands at 0.8100 (Jan 4th 2013 low), followed by 0.8030.


(Source: Reuters)

We would play that short EURGBP with long USDCHF and USDJPY positions as we believe that US yields will continue to strength. In our last article What could wake up the Dollar (from its coma), we said that the US Dollar would need ‘some action after all these policymakers’ talks’ in order to start strengthening against most of the currencies. The next move we are waiting is from Kuroda and BoJ officials after Japanese data continues to disappoint. Yesterday, the Ministry of Finance reported that the current account surplus was smaller than expected at JPY 116.4bn in March (vs JPY 305bn expected). Our target on USDCHF would be at 0.9000; and our first target on USDJPY is at 102.80.