Will Draghi waver: Euro is in the focus

German IFO was much better than expected and points out to German GDP growth above 2%
The market has opened the most important period of the year. Expectation of the ECB's meeting results are clearly overstated: real solutions may disappoint speculators under the current economic indicators and dissentions in ECB. At the same time, stakes on dollar with reagrd to futures continue in the midst of speculations on FRS rates. All attention has been focused on the fundamental factors. Since October, the market has been processing a huge amount of inside information on taking possible measures at the ECB meeting on December 3.

Let's mention only the key painful points:

  1. Most of ECB members are ready to decrease the deposit rate.
  2. The extent of decrease of the deposit rate is being discussed; however, there is the lowest number of contradictions regarding one-off decrease from 0.1% to -0.3%.
  3. The ways of overcoming political and legal consequences have not been found (ECB's mandate forbids monetization of the national debt of the participant countries).
  4. The idea of two-level system of deposit rates, under which the amount of negative rate on ECB's accounts will depend on the amount of money kept there, obviously reflects the German interests. Further decrease of the deposit rate on ECB's accounts can likely result in negative rates on deposits for individuals - that threatens habitual income from savings, pension and insurance systems.
  5. QE expansion via the purchase of municipal bonds and the purchase of bank loans is being discussed on the official level; however, if ECB allows it, the European scenario will develop towards the negative outcome.
  6. Dissentions in ECB are growing: Draghi himself mentioned that he did not take into account the Bundesbank's opinion and does not consult with Wideman. Germany will use all the available levers against further weakening of the ECB's monetary policy - there suits have been filed to the Constitutional Court against ECB's QE program, and in case of Draghi's further resistance, Bundesbank may withdraw from participation in the QE program, which will result in Germany's pull out of Eurozone.
  7. Draghi counts very much on continuous verbal interventions with promises to increase stimulus measures at any further ECB meeting.

A few bits on European statistics:

  • The indicator of inflation expectations in November grew dramatically and although it is still far from the ECB's 2% goal, it is much higher than the values that were on the date of QE launch;
  • German IFO was much better than expected and points out to German GDP growth above 2%;
  • Last week, PMI of Eurozone countries demonstrated the best growth for the previous 4.5 years;
  • Consumer crediting volumes have been growing;
  • The growth of money supply speaks in favor of inflation growth. Considering the current oil prices, we can, at least, predict the absence of deflation threat in Eurozone.

Presently, there is no serious need for the expansion of ECB's stimulus measures; however, Draghi's promises clearly put pressure on the market expectations. So, the following variants are possible:

  1. The lowest level of the purchase of state treasury bills with negative yield is rigidly fixed to the deposit rate in the framework of the QE program - ECB can't purchase state treasury bills with the yield below -0.2%. On the condition of deposit rate decrease to - 0.3%, ECB will be able to include the purchase of German 5-year state treasury bills. However, in order to purchase more short-term debts, it is required to reduce the deposit rate not less than by 20 bps (to -0.4%).
  2. The most likely result of the ECB's meeting will be reduction of the deposit rate by 10 bps (to -0.3%), while the yield of the papers of Eurozone countries should grow.
  3. Today, the driver of euro's decline is the spread between the German and US state treasury bills - exactly due to it, the "fair" value of EUR/USD is assessed below 1.05, and any decision except the reduction of the deposit rate to -0.4% with the promise of further decrease of the deposit rate and the expansion of QE will lead to narrowing of this spread and, correspondingly, to the growth of EUR.
  4. In the nearest future, the likely publication of strong NFP in combination with FRS rate increase will only widen this spread - that will open EUR/USD zone for further fall, but the first response to the ECB's decision may lead to the growth of this pair at least by 2-3 figures.
  5. The expansion of the period of QE program beyond September 2016 (if it is announced now) will show ECB's confusion and weakness; however, it is quite possible.
  6. The bravest expectations of the market regarding QE expansion vary in the range of 10-100 bln euros, but QE expansion even by 5 bln will produce speculative growth o EUR/USD, and in case with 10 bln euros - the movement will depend on the further Draghi's promises.

The following news can also be mentioned:

  1. On Monday, IMF included Chinese yuan into the group of SDR currency reserve basket (as of October 1, 2016 with the weight of 10.92% in the renewed basket), which can be considered a local victory of the Chinese government.
  2. Last week, China's main stock index closed with the fall by more than 5% after several broker firms announced that they were under investigation, and the regulator was conducting an investigation with regard to the activities of the leading brokers. That led to massive sell-offs. However, on Monday, China energized markets by showing manufacturing PMI data on Tuesday above expectations; now, we need to wait for services PMI on Thursday.
  3. This week, Yellen will speak in Washington on Wednesday, and to the US congressional committee on Thursday. Both speeches will be dedicated to economic forecasts, and the speech on Thursday, after Draghi's speech, will be the most important, which may trigger a new wave of opening long positions in US dollars. The official announcement of rate increase is possible at the FRS meeting on December 16.
  4. The last NFP this year will be the last link for such a decision. The data for November must show if slowing down in August-September should be considered as temporary (due to the stock market) or the labor market tendency reversed downward.
  5. In order to move the date of FRS rate increase to 2016, it is required to have about 100K of new jobs (or about 150K and significant downward revision of October data) under the absence of salary growth and unemployment level growth. Also, we would like to bring to your attention indirect data that influence the preliminary opinion: ISM Manufacturing on Tuesday, ADP on Wednesday and services ISM on Thursday.

Technical analysis. Someone very strong puts downward pressure on euro, although the market is already requesting a break before the coming events. EUR/USD is finishing formation of downward triangle (similar upward figure on USD index). In case of euro triangle penetration upward, we can expect a clearly strong response if not a reversal. An accumulation of stops was noticed below the Monday minimum, and a penetration to them promises a decline to 1.0520. There is an interest for purchase to the levels near 1.0462. It is not recommended to open new positions until ECB's decisions and Yellen's speech. Fixation of profit (at least partial) in long positions in US dollar and in short positions in euro is seen as a reasonable decision. The main market movements will begin on Wednesday evening.

作者: Alexander Ward,
ForexChief Currency strategist