Today at 12.45pm, Enter The Draghi. Actually, this morning there were even some doubts over that, with headlines springing up that the monetary policy decision would come “after” that, before the ECB denied it. Perhaps they need a little longer for their lunch to digest, with the big shift in their super-easy monetary policy that’s thought to be just around the corner. Hence the Euro’s 50 pip rally just on those rumours – and a reminder of how jumpy it is out there.
That’s just the way Mario likes it. Over the years he has become the King of Keeping Us Guessing. This affords him maximum flexibility to allow the market to operate as a pressure valve while he curries the consensus around the ECB table. He can leak that he would like looser or tighter monetary policy, then bond markets and the currency can price him accordingly. But if on the day of the ECB meeting he can’t quite get what he wants, those markets will reverse… but then giving him the perfect opportunity to get on the ECB What’s App group and say “I told you so guys LOL”. Which ultimately gets him where he wants to go.
Today, he has managed to create a finely balanced set up:
- Having expected a signal on the taper to come in this meeting, perhaps presaged by a Draghi speech at Jackson Hole, it’s now expected to be presented in the next meeting in October
- …And then start happening in January
- …With Euro strength delaying matters
Bloomberg has an article on economists’ thoughts, with a nice pic of the taper plan here:
Which is amusing, because it suggests that there’s some clear expectations about what the ECB does next. There are not. There cannot be. It was complicated enough when the Fed tried to row back their stimulus, but now you’ve got 19 Eurozone countries trying to agree, just as the biggest one is about to have a fresh election on its head of state. Now, we know it’s almost certainly going to be Merkel (because the polls are always right, ja??), and that, along with the election of Macron, has allowed the ECB to breathe a sigh of relief that they haven’t been drawn into the politics this year. This means they can get on with the economics.
June’s ECB Staff Forecasts had HICP at 1.5% this year, 1.3% next, 1.6% in 2019; and GDP at 1.9 / 1.8 / 1.7%. That was however based on an appreciation in the real effective exchange rate of only ~1%, with EUR/USD set for simple assumption purposes on where it was at the time of the June projections, around 1.0900.
This is the cause of today’s uncertainty. The Euro is up around 5% in trade weighted terms since the ECB last set those forecasts. Draghi said in March 2014 that ‘each 10% permanent effective exchange rate appreciation lowers inflation by around 40 to 50 basis points‘.
The ECB hawks aren’t worried. Nowotny last week said he “wouldn’t over-interpret or dramatize” the rise. Meanwhile the doves, of course, are somewhat concerned, with Constancio saying “The strong worldwide reflationary phase that seemed likely at the beginning of the year has not materialised…Therefore, the tasks of normalising inflation and unemployment to acceptable levels continue to be difficult“.
The upshot is this:
- Ever since an ECB taper came onto the table, there have been several leaks that Euro appreciation might delay its implementation.
- Even the official ECB Minutes notably mentioned the currency for the first time
- But a taper is a-coming, and so the currency will appreciate, not least with the Fed having hit the pause button on their hiking plans
So how worried are the ECB really?
- A higher currency can do their tightening for them
- There is now no need to worry about what this might do to them politically (they don’t want to be blamed for voter discontent)
- But they don’t want to worry about being blamed for building the next bubble either
- They have to cross the taper rubicon eventually
That means the only question for today is:
Either – Swallow the fact the Euro is going higher and just kitchen sink it today
Or – Manage the Euro’s inevitable appreciation by kicking the currency down today and letting it rise from a lower level
Draghi is the master of market positioning (as Blondemoney’s painful post-ECB PnL burns can demonstrate). CFTC data still shows specs are relatively long of EUR/USD. But then every stop-induced move in the currency of the past few weeks has been to the upside, suggesting it’s not that long. Or perhaps rather that the option structures used to play for a higher euro have been those which sell volatility (no-one can afford to be long vol in Target-store-manager-sell-vol world of today), triggering these stops.
The Bank of Canada were bold yesterday, and with good reason. If you’re going to flip, just do it. The market is long Euros but the leaks from the ECB have done enough to keep the market from being one-sided. Draghi has set up the poker table nicely. The cards are dealt. What will you do next? Blondemoney plumps for the kitchen sink. Or, in a less gender stereotyped way, rip off the plaster, get the Euro higher, and deal with any fall out later.