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)

ECB shakes the market

In addition to an ‘interest rates corridor cut’ (refi rate down to 5bps, deposit rate to -0.20% and marginal lending rate to 0.30%), the ECB surprised the market today after Draghi announced that the central bank will start buying securitised loans (portfolios of transparent ABS which will include loans to the real economy and real estate assets) and euro-denominated covered bonds in order to boost lending to small and mid-size companies (further details next meeting on Oct. 2nd).

 It was clear that ECB aims to get the total assets of its balance sheet back to the levels seen in  2012, which is to say a 1 trillion-Euro expansion. The ECB balance sheet (total assets) is now standing at 2.038tr Euros according to the EBBSTOTA index from Bloomberg, 34% lower than June 2012 high of 3.1tr Euros. This would bring back the Fed-to-ECB balance sheet ratio (one of the pair’s strong drivers) to 1.22 within the next few years, down from 1.67 where it stands at the moment, therefore adding pressure to the single currency.

 EURUSD started the day quite flat, trading at around 1.3150, before it was sent to 1.3000 at first during Draghi’s conference and even lower below 1.2940 as core European bonds yields turned negative to 2Y as you can see it below. French 2-year yield is now trading at -2.8bps, Austrian 2-year yield at -0.6%. German yields are now negative up to 4 years.

CoreYields(Source. Reuters)

In addition, the Governing Council reduced its growth and annual inflation to 0.9% and 0.6% for 2014, down from 1% and 0.7% respectively.

If you have a look at the picture chart below, which represents the full ‘ECB bailout scheme’ in order to sustain the European economy, you just start to think ‘what else could they do more?’

MRO, LTRO, ZIRP, SMP, OMT… and now T-LTROs, ABS and covered bonds. There are talks that Europe is heading towards a long period of stagnation / deflation period, where QE will be the only [pretended] option to get out of the negative spiral (have a look at Japan since Abe took office in December 2012 and see if QE is the solution).

ECB-bailing-out-Europe (Source: Bawerk.net)

If we have a look at EUR/CHF, it ‘only’ went down 20 pips (bottomed at 1.2044) after the ECB’s action; therefore we think that the SNB has already started buying some Euros in order to protect its floor at 1.2000.

USDCHF broke through the 0.9300 level to trade at 0.9330 earlier this afternoon, slightly below its 50-percent Fibo retracement of 0.8700 – 0.9980. The next resistance on the topside stands at 0.9450, followed by the psychological 0.9500.

CHFSNB(Source: Reuters)