- Strong Friday close and risk markets continue to rise ahead of the ECB meeting
- Already high ECB expectations were built further after a Bloomberg story that ECB
- president Draghi is trying to secure consensus for a big policy response
- Equity markets are generally higher in Asia – EUR/USD trades just below 1.23
- Focus today is on Swedish GDP and the Italian bond auction
US equity markets closed with strong gains on Friday and thereby ended the week almost two percent higher. Asian markets are higher overnight, despite disappointing Japanese June industrial production, and in general the positive sentiment has been sustained as markets await Thursday’s ECB meeting – though the rebound has lost strength with EUR/USD falling below 1.23 and US equity futures trading marginally in red.
Expectations are very high, which implies that event risks are also very high as the 4% rally in equities, 2.5 big figure rise in EUR/USD, and 100bp drop in the 10-year Spanish government bond yield could easily reverse if European policy makers surprise and do not deliver.
The probability of a policy response at Thursday’s ECB meeting appears high, though. Not only was ECB President Draghi’s statement on Thursday endorsed by Berlin, Paris and Rome but, according to Bloomberg, Draghi is also working to secure support forbond purchases. According to Bloomberg’s central bank sources Draghi will be meeting among others Bundesbank president Weidmann to secure consensus about a plan that would involve EFSF/ESM bond buying on the primary market and ECB bond buying on the secondary market. In addition, further rate cuts and LTROs should be up for discussion.
The question is whether risk markets will manage to stay underpinned until Thursday’s meeting. At least, the elevated event risk means that it will be very risky for investors to position against the current rally. It is not all about the ECB this week, however, as therewill also be a FOMC meeting on Wednesday, a BoE meeting on Thursday and the July US employment report on Friday. While few expect the Fed to signal further QE already
at this week’s meeting, there appears to be more uncertainty about the probability of a surprise cut in the rate the Fed pays on bank reserves (currently 0.25%).
Global Daily
Focus today: We kick off the week quietly on the data front with no tier 1 data until US ISM, non-farm payrolls and both Fed and ECB meetings later this week. The markets today will likely focus on any signs from ECB on when to expect some action. After apparently clear signals last week from ECB president Mario Draghi that the ECB was preparing something, the news over the weekend indicates it may be too early to expect action already this week. Today we will also have Italian auctions of 3, 5 and 10 year paper. On the data front there will be consumer and business confidence from the EU Commission and the UK is set to release CBI reported sales, an indicator for retail sales.
FX markets: The short-squeeze following the EU summit in late June allowed for about a 2.5 big figure spike in EUR/USD. This corresponds fairly well with the rise from Tuesday’s 1.2043 low. Spot momentum is not yet looking as stretched, however, as indicated by the RSI(14), which peaked above 54 when the EU summit rebound ended but currently trades at 47. This indicates further potential. However, it all depends on the ECB.
If European policy makers disappoint and do not deliver this week, we would not be surprised to see EUR/USD back testing 1.20. This is not the most likely scenario, however, which leaves the question: how will the euro react to a strong ECB response? Government bond purchases by the European bailout fund and the ECB should be euro positive via reduced sovereign credit risks and hence lead to further euro short covering and further short-term EUR/USD upside. However, if coupled with a rate cut the effect would be less clear-cut euro positive and much would depend on the degree to which the ECB would manage to extend the rally in Spanish and Italian government bonds.
Scandi Daily
Sweden: Swedish Q2 DP in focus today, we expect +0.5 % qoq/1.2 % yoy above market expectations and Riksbank (0.6 % yoy). If correct it should put some upward pressure on Swedish money market rates and give some support to the krona.
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