The Big Day has arrived and investors are looking at one element, which is, can the president of the European Central Bank can deliver which he promised. Mario Draghi, the president of the European bank has been priming the market since October that more stimulus is on the way, and today, his reputation is on the line if he can deliver or not. How much move there will be in the euro very much depend on two elements which are; the path which the ECB will take to add more stimulus and finally the tone it will adopt in its press conference- the two immensely important components.
The central bank does have handcuffs on it, and how much they can move their hand with these handcuffs, really depend on the economic data of the Eurozone. Another question is, how much ammunition the ECB can utilise to fight against the parties who are resisting against their actions? The data for the Eurozone is very much positive and it has come a long way if you compare this before the ECB announced their QE. The ISM manufacturing data for Spain, Germany, Italy and for the Eurozone have set a solid positive outlook.
Similarly, if we look through the lens of unemployment, German, Italian and the Eurozone’s data released this week have once again strengthen the sentiment for the economic growth. Finally, the economic confidence has also hit one of its finest reading in a prolong time confirming that weaker euro is aiding the economic situation. So, can the ECB still beat the same drum that the economic recovery is not up to scratch and can they produce more noise by beating the same old drums?
Perhaps, the only excuse which they can utilise could be inflation, which is still well far away from their target level and the president has voiced his concern that he is wary of this element. The core inflation data released yesterday missed the forecast of 0.2%, however, it still matched the previous reading of 0.1%. It has come a long way if you compare this reading where it was at the start of this year, -0.6% was the reading at the start of this year. Moreover, as we move forward, the impact of lower price will fade further and hence this number could start moving higher at a much faster pace.
There are a number of tools which Mr Draghi can use for his defense and save himself from backlashing. Firstly, he can always cut the deposit rate, which is standing at -0.2% and this will give him the freedom to inflate his balance sheet. Eighty percent of the market participants have priced this element very much. Secondly, the bank can front load their monthly bond purchase and 2/3 of traders are expecting this outcome. Thirdly, the ECB can announce that they want to prolong their stimulus path beyond 2016 to all the way to 2017. Finally, the most controversial one is adding new sovereign bonds in their purchase list and fifty percent of investors are considering this as an outcome.
The move in the euro today could be in two fold. Firstly, the volatility will pick up when the ECB will announce their deposit rate decision and we think that they can move this rate all the way to -0.4%. This may trigger the initial sell off for the euro and chatter for euro dollar parity will kick off even more. Finally, it will be the press conference when we will see an enormous amount of volatility for the euro.
Disclosure & Disclaimer: The above is for informational purposes only and NOT to be construed as specific trading advice. responsibility for trade decisions is solely with the reader.
by Naeem Aslam