2020 onwards: struggling economy, more QE?

In the past cycle, central banks have been constantly intervening in the market to counter the strong disinflationary force coming from the 3D: Debt, Demographics, Disruption. Figure 1 shows that between the beginning of 2008 and early 2020, the assets from the major 5 central banks grew steadily by a annual pace of $1.25tr per year, for a total of $15tr in 12 years.

As a response to the Covid19 shock, central banks just printed more in order to prevent the economies from falling into a deflationary depression, which resulted in a 7-trillion-dollar increase in central banks’ assets in the past 8 months. The titanic liquidity injections resulted in a significant rebound in equities, especially in the US with the SP500 trading over 100 points above its February high.

With most of the European economies entering a second lockdown, and restrictions also expected to be announced in the US (as the elections are now over), governments will again run aggressive fiscal policies and extend the furlough schemes in order to avoid the rise of social unrest, which will result in more money printing from central banks in the coming months.

Is it as simple as this: the worst the economy gets, the better it is for stocks as it will result in more liquidity injections?

Image
Source: Eikon Reuters, RR calculations

Mind The Rise In The Term Premium!

Introducing the Term Premium

Through the use of economic models, academic research has decomposed the observable long-term bond yields (i.e. US 10Y Treasury bond yield) into the expected path of the real interest rate (r*) and the additional term premium, which is thought as the extra return that investors demand to compensate them for the risk associated with a long-term bond. Using the dominant measure developed by the NY Fed (Adrian et al., 2013), we overlay it with a set of macro and financial variables and look at the pros and cons of a rise in the term premium in the coming months.

Figure 1 shows that the evolution of the US 10Y yield along with the expected r* and the term premium. While we can notice that part of the fall on the 10Y was driven by the decrease in the expected r* from 3.15% to 1.80%, the elevated volatility in the short run was mainly coming from the moves on the Term Premium (TP). The TP hit a historical low of -1.47% on March 9th and is still standing at extreme low level of -1.1%. Many investors had expected the term premium to start rising the US in 2018 and in the first half of 2019, but it surprised most of them by constantly reaching new lows.

Figure 1

fig1Source: NY Fed

Term Premium: a counter-cyclical variable

One important characteristic of the term premium is that it is a counter cyclical variable that tends to rise when the uncertainty around unemployment (or the business cycle) and inflation expectations starts to increase.

Figure 2 (left frame) shows the striking relationship between the unemployment rate and the term premium since 1961. Periods of rising unemployment have been generally associated with a sharp increase in the term premium. Now that we expect the jobless rate to skyrocket following the dismal prints of NFPs and initial claims in recent weeks, could we see a response in the term premium as well?

Figure 2 (right frame) shows another interesting relationship between the US 2Y10Y yield curve and the term premium. We know that the inversion of the yield curve is usually marked by a sharp steepening effect within the next 12 to 24 months as the economy enters a recession. This is referred as a ‘bear steepener’ as the long end of the curve starts rising due to a surge in the term premium. Will the Fed’s emergency measures and QE purchases be enough to deprive the yield curve and term premium from rising significantly in the coming months?

Figure 2

fig2Source: Eikon Reuters

Term Premium vs. inflation expectations

The 2-trillion USD increase in the Fed’s balance sheet as a response of Covid-19 has brought its holding of securities to a new all-time high of $5.85tr. The Fed has recently been buying $625bn of securities each week, which corresponds to an annual pace of $32.5tr and is $25bn more than the entire QE2 run between November 2010 and June 2011. The balance sheet of the Fed is now expected to hit 8 to 9 trillion USD by the end of the year in hopes that it will bring back confidence in the market. Hence, it is fair to raise the following question: will we experience rising inflation in the medium term?

As the term premium is very sensitive to the uncertainty around inflation expectations, it shows an interesting co-movement with the 12-month volatility of the Fed’s balance sheet assets. When interest rates reach the zero bound, central banks run aggressive asset-purchase programs in order to decrease the shadow rate below the neutral rate of interest rate (r*) and stimulate demand and inflation. Figure 3 (left frame) shows that previous periods of rising 12M vol in Fed assets were associated with a short-term increase in the term premium.

Investors could argue that inflation expectations have been falling if we look at the market-based measures – the USD 5Y5Y inflation swap. Figure 3 (right frame) shows that the 5Y5Y inflation swap is currently trading at a historical low of 1.75%, down from nearly 3% in January 2014. However, we previously saw that inflation swaps have been very sensitive to equity and oil prices in the past cycle; in theory, an oil shock should not impact inflation expectations as better monetary policy readjustments from central banks will offset that shock. Hence, these products represent more the demand for inflation hedges (which decreases when energy prices fall), but do not tell us anything about long-term inflation expectations.

Figure 3

fig3Source: Eikon Reuters

Term premium and free-floating bonds

Certainly, moves on the term premium also depends strongly on the amount of free-floating securities in the market. As central banks keep increasing their balance sheet through the purchase of securities such as government bonds, the amount of free-floating bonds have dramatically been reduced in the past cycle. For instance, it was estimated that large asset-purchase programs in the Euro area have decreased the free float of German government bonds from approximately 40% in 2015 to 3% in early 2020 (figure 4, left frame). Figure 4 (right frame) shows how the relationship between the 10Y Bund term premium and the free float flattened in the past few years; low free float is associated with a flat term premium.

In the US, the amount of free float is much higher due to the large quantity of marketable debt securities (USD 16tr) held by the non residents; non-resident holders (NHR) hold nearly 40% of the US debt. Hence, even though the Fed’s aggressive purchases will reduce the free float in the medium term, there is still the risk of a sudden rise in the term premium in the short run as the economy enters a recession.

Figure 4

fig4

Source: Danske, ECB

To conclude, the risk of higher long-term interest rates in the US is still there in the coming months; even though we do expect long-term rates to eventually go to zero, there is still a high probability to see a little short-term surge in the 10Y -plunge in US Treasury prices (TLT), which would significantly steepen the yield curve coinciding with the drastic rise in unemployment.

Great Chart: G10 policy rate vs. World equities

As more and more regions in developed economies have been put under a dramatic total lockdown amid growing concerns over Covid-19, central banks have started to cut rates aggressively in order to avoid a complete market meltdown. We saw in the previous week that both the Fed and the BoE held emergency meetings and cut rates by 50bps, the most since the Great Financial Crisis, benefiting from their positive benchmark interest rate to act faster than the rest of central banks. Economies already experiencing a NIRP policy (i.e. Sweden, Euro area) will probably implement or expand asset-purchase programmes in order to fight against a significant economic shock and therefore implicitly reduce their ‘shadow rate’, a rate first introduced by Fischer Black (1995) that can measure the effects of QE, to lower levels.

However, it is important to note that a significant reduction in benchmark policy rates globally has been associated with sharp equity sell-offs. This chart shows that in the previous two downturns, the GDP-weighted G10 policy rate was cut by approximately 4 percent and coincided with a global equity sell-off of 45% to 55%. Are we set for a similar story in 2020?

Chart. G10 policy rate vs. World equities (source: Eikon Reuters)

fig4

Great Chart: Gold price vs. Negative-yielding debt

Empirical researchers have demonstrated that gold has had many drivers over the past few decades, but has been mainly influenced by interest rates, inflation trends, the US Dollar, stock prices and central banks reserve policies. Baur and McDermott (2010) also shows that the precious metal plays the of a safe ‘zero-beta’ asset in periods of market stress and equity selloffs. For instance, in the last quarter of 2018, US equities (SP500) fell by 14% while the price of gold in US Dollars was up 7.6%. In the short run, participants usually look at the co-movement between gold price and real interest rate (TIPS) to define a fair value of the precious metal (gold price rises when real yields fall and vice versa).

However, gold has shown a stronger relationship with another variable in recent years: the amount of negative-yielding debt around the world. This chart shows us the striking co-movement between the two times series. After oscillating around USD 8 trillion between the beginning of 2016 and the end of 2018, the amount of negative-yielding debt doubled to nearly USD 17 trillion in the first half of 2019 amid political uncertainty and concerns over global growth, levitating gold prices from $1,280 to $1,525. However, we have noticed that investors’ concern has eased in the past two months, normalising global yields (to the upside), increasing the US 2Y10Y yield curve back to 25bps after turning negative in the end of August, therefore reducing preference for ‘safe’ assets such as bonds. The amount of debt yielding below 0% has dropped significantly since the end of August to USD 11.6 trillion this week, dragging down gold prices to $1,460. We think that market participants have overreacted to the global growth slowdown in the first half of the year and that the rise in leading indicators we have observed in the past three months (i.e. global manufacturing PMI) will continue to push preference for risk-on assets. The amount of negative-yielding debt could easily come back to its 2016-2018 8-trillion-dollar average in the following months, hence emphasising the downward pressure on gold prices. It looks like gold is set to retest the $1,350 – $1,400 support zone in the short run (which used to be its resistance zone before the 2019 rally).

Chart.  Gold price (in USD) vs. amount of negative-yielding debt (tr USD) – Source: Bloomberg, Eikon Reuters.

Gold

 

 

Great Chart: ECB Total Assets vs. EuroStoxx50 (18M Lag) – Yearly Change

One of the main topics of the year is the central banks’ balance sheet unwind, and the potential effect it can have on asset prices. As JP Morgan (and other sell-side institutions) pointed out, if we look at the annualized monthly net bond flows, the top 4 central banks (Fed, ECB, BoE and BoJ) will switch to net sellers in October 2018 (here). BNP Paribas published an interesting chart lately of the weighted average 10-year G4 bond yield overlaid with the G4 monthly bond purchases (here); we can clearly see that the increase in the total purchases has helped to push overall 10Y yields on the downside since 2010, hence eased financial conditions and stimulated the refinancing activity. However, what will happen to LT yields now that the purchases are expected to fall in 2018?

Many market participants have argued that the constant increase in central banks’ balance sheet has levitated all asset classes, and particularly the stock market; therefore, one economic area we are watching closely during the unwind is the Euro zone. If we look back three years ago, when Mario Draghi announced the launch of the 60-billion Euro bond-buying program on January 22nd, 2015, the ECB balance sheet was totaling 2.15tr Euros and the equity market EuroStoxx50 was trading at 3,400. As of today, the central bank’s assets are north 2.3tr Euro (the ECB balance sheet surpassed the Fed’s one last summer and is now worth 4.5tr Euros), while the EuroStoxx50 Index is up a mere 200pts, currently trading at 3,600 (here). We can clearly notice that the ECB effect on European equities was non-existent. It looks like the European equity market has been a dead market over the past couple of years; the Eurostoxx 50 has been trading sideways within an 800-point range between 2,900 and 3,700 and sits at its 50% Fibonacci retracement from its mid-June-2007 peak to Feb-2009 trough.

Hence, we chose this week to overlay the yearly change in the ECB balance sheet’s total assets with the yearly change in the equity market (18-month lag). As you can see, the two times series have shown some co-movements since the Great Financial Crisis; a decrease in the ECB assets is usually associated with a negative YoY performance in the EuroStoxx50 18 months later. For instance, the ECB balance sheet yearly change switched from +60% in June 2012 to -24% in January 2014 amid early LTROs reimbursement by European banks. If we look at the lagged performance of the equity market, the yearly change in the EuroStoxx50 index went from +20% in the summer of 2012 to -18% in June 2014.

In October 2017, the ECB cut its bond-buying program to 30bn Euros a month starting January 2018 for a period of 9 months, and the market expects that the central bank will taper QE to final three months of the year. With the yearly change on the ECB assets starting its downward trend, our question is the following: will the growth and investment story in the Euro area offset the expected downturn in equities?

Chart: ECB Total Assets vs. EuroStoxx50 (18M Lag) – Yearly Change (Source: Reuters Eikon)

ECB vs Asset.png

Monetary Policy Coordination: From Global Easing to Global ‘Tightening’

Abstract: An interesting series of central-bank announcements over the past semester confirmed our view of a global central banking monetary policy coordination. The first two major players that hinted in a speech that the central bank might slow down their asset purchases were the ECB and the BoJ; but more recently we heard hawkish comments coming from the BoC, RBA and even the BoE. In this article, we first review the quantitative tightening (or the Fed balance sheet reduction program), followed by some comments on the current situation in the other major central banks combined with an FX analysis.

Link ==> US Dollar Analysis 2

Introducing the 3D challenge – Debt, Demographics and Disruption (with a US case study)

Abstract: As a response to the Financial Crisis of 2008, central banks have been running persistent loose monetary policies (NIRP and aggressive asset purchase programs) in order to generate some growth and inflation. Even though the measures chosen by policymakers mainly came from the burst in the housing market (US and Europe), developed economies have also been cornered with another long-term big issue: the 3D problem – Debt, Demographics and Disruption. Demographics reveal a dramatic aging of the developed world’s population (‘Baby Boom effect’), which has been playing a role in the desire of consumers to save more than actually spend. In addition, the long-term solvency of public and private plans has also been a growing concerns across the developed nations, adding pressure on current workers to increase their amount of savings based on a shift in expectations of higher taxes to sustain the secular change in demographics. The effect of an increase in savings have been one of the main factors of a decrease in inflation expectations across the world in addition to a sluggish growth, forcing policymakers to maintain a loose monetary policy, cutting rates to even negative territory and diversifying the asset purchase programs (corporate bonds, ETF and Real estate). The slowdown of inflation, and even deflation for some countries, is an issue for developed nations as it increases the country’s debt in real terms, putting the country under pressure and questioning its long run sustainability.

We then look at the US economy for our case study on the 3D problem. Our analysis is composed of three sections: in the first one we quickly review US demographics challenge, then in the second section we present the US Federal and Household debt, and in the third part we introduce Disruption in different sectors of the US economy.

Link ==> 3D Problem

FX positioning ahead of the September FOMC meeting

As of today, most market participants are getting prepared [and positioned] for the FOMC meeting on September 20/21st in order to see if policymakers stick with their Jackson-Hole hints, therefore we think it is a good time to share our current FX positioning.

Fed’s meeting: hike or no-hike?

We think that one important point investors were trying to figure out the last Jackson Hole Summit last week was to know if US policymakers were considering starting [again] their monetary policy tightening cycle after a [almost] 1-year halt. If we look at the FedWatch Tool available in CME Group website, the probability of a 25bps rate hike in September stands now at 18% based on a 30-day Fed Fund futures price of 99.58 (current contract October 2016, implied rate is 42bps).

CME.png

(Source: CME Group)

In addition, if we look at the Eurodollar futures market, the December Contract trades at 99.08, meaning the market is pricing a 1% US Dollar rate by the end of the year. We can clearly notice that the market expects some action coming from US policymakers within the next few months. However, recent macroeconomic data have shown signs of deterioration in the US that could potentially put the rate hike on hold for another few months. Following last week disappointing manufacturing ISM data that came out at 49.4 below its expansion level (50), ISM Service dropped to 51.4, its lowest number since February 2010 and has been dramatically declining since mid-2015. We strongly believe that there are both important indicators to watch, especially when they are flirting with the expansion/recession 50-level. We can see in the chart below that the ISM manufacturing PMI (white line) tracks really ‘well’ the US Real GDP (Annual YoY, yellow line), and as equity markets tend to do poorly in periods of recession we can say that the ISM Manufacturing / Services can potentially predict sharp drawdowns in equities.

Chart 1. ISM – blue and white – and Real US GDP Annual YoY – yellow line (Source: Bloomberg)

ISM_US.JPG

Another disappointment came from the Job market with Non-Farm Payrolls dropping back below the 200K level (it came out at 151K for August vs. 180K expected) and slower earnings growth (average hourly earnings increased by 2.4% YoY in August, lower than the previous month’s annual pace of 2.7%).

This accumulation of poor macro figures halted the US Dollar gains we saw during the J-Hole Summit and it seems that the market is starting to become more reluctant to a rate hike in September. The Dollar Index (DXY) is trading back below 95 and the 10-year rate is on its way to hit its mid-August 1.50% support (currently trades at 1.54%). What is interesting to analyse is which currency will benefit most from this new Dollar Weakness episode.

FX positioning

USDJPY: After hitting a high of 104.32 on Friday, the pair is once again poised to retest its 100 psychological support in the next few days. This is clearly a nightmare for Abe and Kuroda as the Yen has strengthen by almost 20% since its high last June (125.85). If we have a look at the chart below, the trend looks clearly bearish at the moment and longs should consider putting a tight top at 105. we would stay short USDJPY as we don’t see any aggressive response from the BoJ until the next MP meeting on September 21st.

Chart 2. USDJPY candlesticks (Source: Bloomberg)

EURUSD: Another interesting move today is the EURUSD 100-SMA break out, the pair is currently trading at 1.1240 and remains on its one-year range 1.05 – 1.15. As a few articles pointed out recently, the ECB has been active in the market since March 2015 and has purchased over 1 trillion government and corporate bonds. The balance sheet total assets now totals 3.3 trillion Euros (versus 4 trillion EUR for the Fed), an indicator to watch as further easing announced by Draghi will tend to weigh on the Euro in the long run. The ECB meets in Frankfurt on Thursday and the market expect an extension of the asset purchases beyond March 2017 (by 6 to 9 months). We don’t see a further rate cut (to -0.5%) or a boost in the asset purchase program for the moment, therefore we don’t think we will see a lot of volatility in the coming days. we wouldn’t take an important position in the Euro, however we can see EURUSD trading above 1.13 by Thursday noon.

Chart 3. EURUSD and Fibonacci retracements (Source: Bloomberg)

Another important factor EU policymakers will have to deal with in the future is lower growth and inflation expectations. The 2017 GDP growth expectation decreased to 1.20% (vs. 1.70% in the beginning of the year) and the 5y/5y forward inflation expectation rate is still far below the 2-percent target (it stands currently at 1.66% according to FRED).

Sterling Pound: New Trend, New Friend? The currency that raised traders’ interest over the past couple of weeks has been the British pound as it was considered oversold according to many market participants. Cable is up 5% since its August low (1.2866) and is approaching its 1.35 resistance. We would try to short some as we think many traders will try to lock in their profit soon which could slow down the Pound appetite in the next few days. If 1.35 doesn’t hold, then it may be interesting to play to break out with a new target at 1.3600.

Chart 4. GBPUSD and its 1.35 resistance (Source: Bloomberg)

GBP.JPG

We would short some (GBPUSD) with a tight stop loss at 1.3520 and a target at 1.3350. No action expected from the BoE on September 15th, Carney is giving the UK markets some ‘digestion’ time after the recent action (rate cut + QE).

USDCHF: For the Swissie, our analysis stands close to the Yen’s one, and therefore we think the Swiss Franc strength could continue in the coming days. we like 0.96 as a first ‘shy’ target, and we would look at the 0.9550 level if the situation remains similar (poor macro and quiet vol) in the short term.

AUDUSD: Australia, as many other commodity countries (Canada, New Zealand), remains in a difficult situation as the deterioration of the terms of trade will tend to force RBA policymakers to move towards a ZIRP policy. However, lower rates will continue to inflate housing prices, which continue to grow at a two-digit rate. According to CoreLogic, house prices averaged 10-percent growth over the past year, with Sydney and Melbourne up 13% and 13.9%, respectively. Australian citizens are now leverage more than ever; the Household debt-to-GDP increased from 70% in the beginning of the century to 125% in Q4 2015 (see chart below). This is clearly unsustainable over the long-run, which obviously deprives policymakers to lower rates too ‘quickly’ to counter disinflation. As expected, the RBA left its cash rate steady at 1.50% today, which will play in favor of the Aussie in the next couple of weeks. One interesting point as well is that the Aussie didn’t react to an interest rate cut on August 2nd, something that Governor Glenn Stevens will have to study in case policymakers want to weaken the currency. There is still room on the upside for AUDUSD, first level stands at 0.7750.

Australia.png

(Source: Trading Economics)

Chinese Yuan: The Renminbi has been pretty shy over the past two month, USDCNH has been ranging between 6.62 and 6.72. The onshore – offshore spread is now close to zero as you can see it on the chart below (chart on the bottom). We don’t see any volatility rising in the next few weeks, therefore we wouldn’t build a position in that particular currency.

Chart 5. CNY – CNH spread analysis (Source: Bloomberg)

CNH spread.JPG

 To conclude, we think that we are going to see further dollar weakness ahead of the FOMC September meeting as practitioners will start to [re]consider a rate hike this time, especially if fundamentals keep being poor in the near future.

Only BoJ matters…

Back in September 2014, we wrote an article It is all about CBs where we showed different central banks’ balance sheet as a share of the country’s GDP, which we thought could help explain exchange rates better than some macro models.

As you can see it on the chart below, the Bank of Japan’s balance sheet has been expanding drastically over the past three years and now held a total of 410tr Yen in assets. For an economy of roughly 500tr Yen, the ratio BoJ’s asset – to – GDP stands now at 82% (vs 20 to 30% for central banks).

Chart 1. BoJ Assets (Source: Japan Macro Advisors)

BoJAssets

When you think about it, the BoJ currently holds:

  • 35% of the JGBs (a ratio that is expected to grow to 50% by the end of 2017 – see chart 2).
  • 55% of the country’s ETFs (Chart 3). The BoJ is currently purchasing 3.3tr Yen of ETFs on an annual basis; if it accelerates its program to an annual rate of 7tr Yen, the central bank could become the first shareholder in about 40 of the Nikkei 225’s companies by the end of 2017 according to Bloomberg’s calculations.

Chart 2. BoJ’s JGBs holdings (Source: Japan Macro Advisors)

JGBsHolding

Chart 3. BoJ ETFs holdings (Source: Bloomberg)

ETFsJapan

On January 29th, Kuroda announced that the central bank will adopted negative interest rate policy in order to revive growth (and inflation) in the world’s third-largest economy. Like in the Eurozone (and many countries in the world), the BoJ has been charging a fee to excess reserves that financial institutional place at the central bank over the past three months now. However it doesn’t seem that the results are effective: Japan CPI switched to negative territory in March (-0.1% YoY) and is on the verge on entering into a quintuple recession since the GFC (see chart 4).

Chart 4. Japan’s GDP growth rate (Source: Trading economics)

JapanGDP

It looks like the market was expecting another ‘move’ from the BoJ overnight, and was disappointed by the status quo. The Nikkei index dropped 1000 points to close at 16,666 and sits now on its 50-day SMA, while USDJPY (white line) crashed almost 4 figures to 108, bringing down SP500 futures (blue line) with him to 2075. Therefore, these moves can conclude that for Japan, today, ‘only’ the BoJ matters in terms of news and the best you can do to ‘invest’ is to frontrun what Kuroda is doing.

Chart 5. USDJPY and SP500 futures (Source: Bloomberg)

USDJPYSP500

Some analysts or traders see a buy on dips opportunity at the moment (at around 108), however we would wait ‘til the US opens to decide such a trade. The VIX index (see chart below) has been trending upward over the past few days, which means we could see a couple of volatile days and a fly-to-quality to safe havens such as the Yen (or the Euro as well).

Chart 6. VIX index (Source: Bloomberg)

VIXindex

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)