Macro 2: Euro update

After the first part on Japan, the second one will give a current status on the Euro Zone economy and the ECB. As in Japan and US, the deflationary cycle has also been a big issue (the annual HICP inflation rate has been moving around 0% over the past year) due to this commodity meltdown.

QE recap: As you know, Mario Draghi announced in January last year that the Central Bank will start expanding its Balance Sheet. The QE programme, called the Public Sector Purchase Programme (PSPP), started on March 9th 2015 and was first planned to last until September 2016. The purchases will be split between sovereign bonds and securities from European institutions and national agencies, and will amount a total of €60bn worth of bonds each month. As you can see it on the chart below, the announcement was quite a success if we look at the stock market; Eurostoxx 50 Index (candles) went up 28% between January 2015 low and April’s high of 3,836. At the same time, the programme also pushed down the single currency (green line) to 1.05 against the greenback, making the dream of certain EU’s officials come true.

EuroMarket.jpg

(Source: Bloomberg)

However, it didn’t take too long for the situation to change. The 10Y German Bund yield surged from a low of 4.9bps reached on April 17th to a high of 105bps on June 10th, a net change of 1% in simply 6 weeks. At the same time, the equity market went down 500 points and the Euro surged to 1.15, on rumours that the Fed will lose its ‘patience’ and start a tightening cycle and a weak and irreversible EMU. If we look at the moves on the interest rate market (European sovereign bonds and the single currency) since the famous meeting in May 2014, it is clear that the market’s participants had been front running Draghi on the basic rule of the ECB’s Will To Power. However, the two charts (especially the moves on the German Bunds) describe that this situation can change suddenly, drastically and very quickly.

GermanBund.PNG

(Bund 10-year, source Bloomberg)

In order to calm those market moves and restore a new bullish and stable trend in the market, the ECB’s answers were quite limited and combined a few promises (ECB ‘unlimited options’ jawboning, what does it really mean?), with a decrease in the deposit facility rate (from -0.2% to -0.3%) and an extension of the PSPP programme by an extra six months (until the end of March 2017). We saw that the market reacted negatively to those news and the EuroStoxx 50 Index trades now more or less at the same level (3,000  points) than in January last year (in order words, QE failure…).

When it comes to the Euro, there are a few things that fascinate me as it usually concerns more participants than its 19-nation economy. First of all, the chart below shows the deposit rate of the following countries’ central bank:

  • ECB at -0.3% (Blue/White line)
  • Sweden Riksbank at -0.35% (Yellow line)
  • Denmark at -0.65% (Red line)
  • Swiss SNB at -0.75% (Purple line)
  • Norway (Base Rate) at 0.75% (Green Line)

Deposit Rate.PNG

(Source: Bloomberg)

As you can see, all CBs switched to NIRP policies (expect Norway) over the past year to counter this deflationary cycle and sluggish growth; it seems that all other European economies (with Switzerland) have been forced to follow the ECB moves in order to avoid a sharp local currency appreciation (vs. the Euro). Therefore, when you hear about the ECB’s decisions, you must think what will happen to those economies as well (and some Eastern European ones as an extent). We will see what are the consequences and reactions in the near future (12 months) as we know that NIRP policies tend to inflate asset prices ‘artificially’, especially the real estate market (look at Sweden, or Norway for instance), and force banks to pass on the negative carry to their clients (questioning the value of money as it is better to hold money under the mattress than in a negative interest-bearing bank account).

Secondly, the Euro has been reacting positively (and violently) to a few market events, like the August flash crash (EURUSD surged from 1.1365 to 1.1714 in a single trading session on August 24th) or the Draghi’s disappointment on December 3rd (EURUSD went up by 5 figures that day). We are always questioning what can explain that? A first answer could come from the fact that the Euro has become one cheap funding currency, and during periods of stress, the carry unwinds lead to some Euro appreciation. It can explain some strength, but not sure about those drastic moves. Another explanation could be that sometimes, the Euro acts a safe-haven currency. We explained it a couple of articles (here and here), that we have to look at how the market is currently positioned (late correlation with the VIX index).

A quick EURUSD analysis:

At the moment, we visualize the Euro as a ball still full of air that everybody is trying to sink under water. However, everybody’s weight (which can be described as market participants’ view) can change and if it becomes too light, the ball can come up to the surface quite quickly naturally). The EURUSD-pair looks rangy; a strong support stands at 1.07 with a resistance area 1.10 – 1.1050 (100 and 200 SMA) where the bears are waiting to short. One careful thing to watch (and potentially play) is in the upside in case the 1.1050 level is broken; this could trigger many stops and bring the Euro to last year’s highs (1.14 – 1.16).

EURUSD.PNG

(Source: Bloomberg)

Post FOMC Analysis, Dollar Flash Crashes…

This week has been full of macro events (four central banks meetings – BoJ, Norges Bank, SNB and the Fed), however all eyes were on the FOMC statement that came up yesterday. Dovish stance from Yellen in addition to 2015 forecasts revised on the downside created Dollar ‘Flash Crashes’, with the FX market completely out of control. The US Dollar index was trading around 100 yesterday morning, then went down from 99.50 to 98.00 after the FOMC, and eventually ‘flash-crashed’ after the US close. EURUSD (and Cable) soared by 400 pips (and 500 pips) to 1.1040 (and 1.5160 respectively), USDCHF down 4 figures as well down to 0.9620. The yen was less reactive (which clearly shows the declining Yen Pavlovian response the risk-off environment, USDJPY went down ‘only’ 200 pips to 119.30.

To review the FOMC statement briefly, the Committee revised down all 2015 forecasts since the previous Summary of Economic Projections (SEP) released on December 17 last year. The median dot plot for year end 2015 decreased from 1.125% to 0.625% (down by 50 pips). In addition, looking at the Fed’s dot plot for the year 2016 and 2017, we can see that the median dot for 2016 fell to 1.875% in March (vs. 2.5%) and decline to 3.125% from 3.625% for 2017.

FOMC DOT plot

 (Source: Fed’s website)

Furthermore, if we look at the table below which shows the advance release of the SEP, we can see that the central tendency for GDP this year was decreased to 2.3%-2.7% (from 2.3% – 2.7%), PCE inflation (the inflation measure watched by the Fed as the PCE index covers a wide range of household spending) went down to 0.6% – 0.8%, compared to 1.0% – 1.6% three months ago.

FED Forecasts

(Source: Federal Reserve’s website)

While the Dollar has been recovering all day (especially during Asia, USD index now trades back at 99.40, with EURUSD back down to 1.0660, USDCHF up to 0.9910, Cable down to 1.4740 and USDJPY at 120.80), the market is still a bit ‘stress’ with all core bond yields trading to lower levels (See appendix, Bund at 19bps, US 10Y at 1.95% or UK Gilt at 1.52%) and peripheral EZ bonds trading higher than yesterday’s levels.

As a result, the equity market (S&P500) is back on track after a quick 70-point bear consolidation as I was looking for (see tweet @LFXYvan on Feb 26). If we look at the chart below, we can see that the 100 SMA has acted as a sort of support where the market found some potential buyers-on-dips. Over the past few months, it looks like if the 100 SMA didn’t hold, the 200 SMA was doing the rest of the job (except in mid-October).

SP500

(Source: FXCM)

Even though the equity has lost a bit of ‘power’ since the Fed stepped out of the bond market at the end of October last year (the bear consolidation are becoming more and more recurrent), I still believe there is some potential room on the upside based on yesterday’s comments and readjustments.

I am curious to know how the US policymakers will play the rate hike within the next few months (will there be one in June?), as even if the job market has continued to show some strong figures with a NFP report at 295K in February and an unemployment rate at 5.5% (close to full employment according to economists), there has been a lots a disappointing macro figures. See list below with all the misses in just the past month…

Misses US

 (Source: ZeroHedge)

Earlier today, the SNB left its deposit rate negative at -0.75% and jawboned a bit about the recent CHF appreciation. EURCHF is trading at 1.0550, down 2.5 figures in the past month and potentially ‘hurting’ the Swiss economy (Swiss is also part of the ‘Currency War’ party). Norway unexpectedly left its interest rates unchanged and signalled in its report that another cut was planned to protect the Norwegian economy from the plunge in oil prices. The NOK rocketed against the greenback earlier today, down from 8.37 to 8.07 on this hawkish surprise. As a reminder, Oil (and gas) generate more than 20% of Norway’s output, and the country may be in difficulty if this low-oil-price era persists. Norway may have to ‘tap’ into their sovereign wealth funds – Government Pension Fund Global – (approx. $850bn) in order to support their annual budgets this year. However, the maximum that the government could spend from oil revenue is 4% of the fund (by law).

Otherwise, no surprise from Japan and the BoJ stood firm on Tuesday, leaving its monetary policy unchanged (80tr Yen of asset purchases annually, mostly JGBs), even though policymakers acknowledged that prices might start falling in the coming months. Consumer prices in Japan rose 2.4% YoY in January, the same as the previous two months and down from 3.7% in April last year.

 Appendix: Bonds yields…

BBG

 (Source: Bloomberg)