Thoughts from the Trading Trenches
20 Years ago | May 01, 2014 12/2/23, 12:00 AM
In the May issue:
C’mon ECB, Send Us a Signal?
There was a trader on the GVI Forex forum who often used the term, “bid in an offered market” to describe when a currency trades better bid when it is actually better offered. I would like to think this is the case with the EURUSD, which has confounded most forecasts by holding firm through the first four months although as of this writing it is barely up on the year (+0.6%).
Focus on the ECB
So the question is what it would take to break this currency out of its tight range and give traders a trend to finally trade. What is clear is that there has been demand for EUR with the performance of peripheral bonds (e.g. Spain, Italy, etc.) suggesting large capital inflows giving support. There is also the ECB, which has not reacted so far to tightening liquidity and deflation fears, preferring to use the cover of its medium term inflation forecasts to keep policy steady.
This brings us to the May 8 ECB meeting and what seems like a monthly ritual of looking for a sign that an easing of monetary policy (e.g. rate cut into negative territory or quantitative easing) is more than just idle words. In this regard, the following is from our March newsletter that is worth repeating to give a perspective as I could have written the same words this month as well.
This is a hard call as the ECB has a history of disappointing market expectations. So here we go again as speculation is starting to build that the ECB may ease policy given inflation that has fallen below 1% per annum and farther from the around 2% medium-term target level, raising concerns over deflation. In this regard, there seems to be two options to ease policy: cut short-term rates and move them into negative territory or quantitative easing by buying bonds on an unsterilized basis.
I generally take a logical approach and it seems a no brainer for the ECB to ease policy and weaken the EURO. A weaker currency would be a way to boost prices and at the same time give some stimulus to an underperforming economy (Germany being the exception). The low level of inflation gives it room to ease as its mandate is a single one, price stability. However, ECB and Euro zone officials have showed little concern over the firm EURO. In addition, at the February ECB meeting, president Draghi indicated something to the effect that the central bank did not raise rates when inflation exceeded its target, implying it may be doing the same by not cutting rates on the current undershoot.
So it is market logic vs. the ECB and the latter often prevails. This is why I say that If this wasn’t the ECB, the case for easing policy would be a strong one. In any case, the start of March will see the ECB meeting as a key focus, especially because there will be revised economic forecasts that the central bank will use in making its decision whether to ease or not. In a market starved for a trend, it would be nice if the ECB joined the currency wars and gave a signal to sell its currency. Given its history we can only hope although it also says don’t hold your breath.
Cap on the EURUSD Upside?
There has been one change since I wrote the above and that is a coordinated effort to put a cap on the EURUSD upside. Several ECB officials have indicated that if the EURUSD gets too strong there will be a policy response due to the deflationary impact of a stronger currency. This suggests a limit on the upside (1.40?) as the ECB stands ready to knock it back down if it gets too high.
So if we know where the top may be, why hasn’t the market been able to drive it lower? I suggested some of the reasons why the EUR has been strong and if you add in the ever present diversification of global reserves (e,g, China selling dollars to rebalance reserves accumulated in weakening the CNY), the common currency has been one resilient puppy.
C’mon ECB, Send Us a Signal?
With the US economy digging out from a harsh winter, signs are that activity is rebounding from a weaker-than-expected first quarter (just reported at +0.1% annualized) and if it performs as many forecast, the rest of the year will see solid growth. This gives the forex market a scenario where the dollar should go higher but this has been the case since the start of 2013, when consensus forecasts were calling for a stronger currency based on economic fundamentals. Also, with the Yellen led Fed seemingly in no rush to raise short-term rates, the market is looking to the ECB for a sign.
So, c’mon ECB send us a signal. Forget what Germany wants and look at the overall EZ economy. QE may be too much to ask for but how about a rate cut into negative territory. I never bet on the ECB given its history of disappointing market expectations or should I say hopes. So don’t hold your breath for a May surprise. If not then, look for June as a more likely time when speculation might build that the ECB sends a signal to push the EURUSD lower by easing policy. Much will depend on the inflation data as that has become a key indicator (not just for the EZ but other countries) after being pushed into the background for many years. In the meantime, watch how EURUSD closes vs. 1.38 as solidly below it would be needed to shift the current range from 1.37-1.40 (actually 1.3670-1.3770) to a lower one (e.g.1.35-1.38). As of this writing, EURUSD has closed 1.38xx in 15 of the last 16 days, the lone exception was on April 21 when it closed just below it, leaving the market to ponder what it will take to break the current logjam.
To sum up, waiting for the monthly ECB meeting and a signal reminds me of Groundhog Day. If it is cloudy when the groundhog comes out of its burrow, spring will come early (i.e. ECB monetary policy ease). If it is a sunny day, the groundhog sees its shadow and goes back to its burrow, indicating winter will continue for another 6 weeks (i.e. another month to the next ECB meeting).
Jay Meisler, founder
Global Traders Association
