Q: How many central bankers does it take to screw in a light bulb?
A: Just one – he holds the light bulb and the whole world revolves around him.
Share indexes are up across the board this morning, with investors expecting the European Central Bank to refill the global monetary punchbowl at its meeting tomorrow. Asian equities are sitting at a six week peak, while European bourses trade at nosebleed seven year highs.
The Japanese yen is up roughly one percent against the dollar after the Bank of Japan left its policy statement materially untouched. Sterling is down in response to Bank of England minutes showing that voting members are dropping rate hike calls as inflation veers downward. All eyes are on Frankfurt however.
Broadly, traders in the currency marketsarepositioned for an underwhelming announcement. Asset purchaseexpectations have coalesced around the 500 billion euro mark, with many observers content to extrapolate the institution’s long history of caution and hesitancy forward.
We suspect that this skepticism is somewhat misplaced. Governing Council members are certainly concerned that the slow and steady approach is not working, and are well aware of the broader market context. On the condition that each Eurosystem central bank is responsible for buying the bonds of its own country, we could see a programme launched that consists of a 1 trillion euro mix of sovereign, corporate and supranational debt purchases, combined with an open-ended commitment to buy more in the event that inflation does not hit the 2% target within a reasonable timeframe. This time, Draghi could breathe fire.
It’s important to remember however, that price dynamics in the currency markets are not nearly as simple as they often appear on the surface.Quantitative easing could certainly dilute the euro’s value in the short term, but is designed to boost economic activity by accelerating the flow of cash throughout the common currency area. Certain lending restrictions could also make it more difficult for speculators to borrow euros while investing outside the economic bloc, meaning that downward pressure could be alleviated.
Thus, there is a strong possibility that a carefully-tailored announcement initially pushes the euro down, before pulling it in the opposite direction. In other words, the devil is in the details – and those details are difficult to discern from a headline.
As such, we cannot overemphasize the value and importance of placing automated orders in advance of this critical market event. Trigger fingers will be very itchy, meaning that moves could be incredibly short-lived.
Forthose who have seen substantial upside as the euro has declined over the past few months, it is only prudent to consider locking upa portion of any gains- or using currency options to fencethem in.
Here in the frozen North, traders are positioned extremely defensively ahead of the Bank of Canada announcement scheduled for 10:00 Eastern time this morning. In the accompanying Monetary Policy Report, Bank economists are widely expected to sound a cautious note on the country’s economic prospects, as lower oil prices interact with elevated debt levels to drive growth forecasts lower.
After yesterday’s disappointing manufacturing numbers, market chatter around the possibility of a rate cut later this year has increased, putting pressure on the currency. Although we have long been much more dovish on Canadian interest rates than our counterparts, we consider such a move unlikely, given the risk that debt loads could increase, and the widening differential that already exists between the loonie and the greenback. The Bank has stood on the sidelines for 60 meetings straight, and is likely to stick to its guns for the time being.
Again, potential exists for two-way movement in the currency. With bearish positions stacked up against it, any hint of optimism could trigger a sharp reversal.
All in all, we’re looking at a volatile few days in the foreign exchange markets. Talk to your trading teams to develop a strategy.
Further reading:
European Central Bank
US housing starts beat, building approvals miss
