The European Central Bank promised in January to "review and reconsider" its monetary stance this week. The question, as BloombergBriefs notes, is not if policy makers will ease but how. Haruhiko Kuroda's humbling in FX markets shows what Mario Draghi is up against tomorrow: namely, that even the most forceful policy decisions can be overwhelmed by events, positioning, or sentiment. Draghi has a number of options (some more and some less priced in) but most crucially there two large gaps to be filled in European Stock indices - the question is which is filled first?
As BloombergBriefs adds, ECB members have been relatively shy about communicating their intentions for this meeting. That’s because — as the minutes of the last one revealed — they decided that "it had to be avoided, by means of appropriate communication, that markets developed undue or excessive expectations about future policy action, bearing in mind the market volatility experienced around the December 2015 monetary policy meeting." In other words, this time they have been cautious not to set the rhetorical bar too high to avoid another market disappointment.
So, as The Wall Street Journal explains, Draghi has a few options:
The ECB could move interest rates.
They are the ECB’s primary, and least controversial, stimulus tool. Analysts expect the ECB to cut its deposit rate — charged to banks for storing their funds with the central bank — by at least a 0.1 percentage point, to minus 0.4%.
A cut steeper than this would likely weaken the euro against other major currencies, and reduce short term lending rates, both things that are positive from the ECB’s perspective. On the other hand, rate cuts have also squeezed income streams for banks, cutting the amount they can make by lending.
[Though we note the market is already pricing in far more rate cuts...]
To offset some of the pain for banks, the ECB might impose the most punitive rate on only a portion of banks’ reserves. Japan, Switzerland and Sweden already have such multi-tier systems. Another way to ease the pressure on banks could be to cut the ECB’s main interest rate to zero from 0.05%.
They could also expand quantitative easing.
The ECB is currently buying about €60 billion a month of mainly eurozone government bonds, as well as asset-backed securities and covered bonds. Economists expect the ECB to accelerate its purchases by at least €10 billion per month, to €70 billion, and perhaps extend their duration by six months, to September 2017.
Taken together, those two measures would boost the program by €540 billion to €2 trillion, or around 20% of eurozone gross domestic product, said Ken Wattret, an economist at BNP Paribas in London.
When the ECB first announced its bond buying program, European stocks rallied, and bond yields tumbled. A bigger than expected expansion could have this effect again, as the purchases raise the price of bonds and shift investors into other markets.
Part of any expansion could be a loosening the restrictions on QE.
There are five major constraints right now.
- Bonds are purchased in proportion to a country’s capital key, a measure of the size of each economy and population.
- The ECB won’t buy more than 33% of any individual bond issue.
- It won’t buy more than 33% from any individual issuer.
- The bonds purchased must mature in no less than two years, and no more than 30 years.
- And it won’t buy bonds that yield less than its deposit rate.
Dropping the latter requirement would be the least contentious tweak, economists say, and would greatly expand the pool of eligible assets, particularly of German bonds.
Cutting the deposit rate as expected would, of course, make more bonds with negative yields eligible for the bond buying program. However, yields are likely to fall in reaction to any rate cut too, making some bonds ineligible again.
The ECB could also buy other stuff.
The ECB could buy corporate or senior bank bonds. That would be a “highly effective signal” with powerful effects, but would likely encounter serious resistance from some council members, said Holger Schmieding, chief economist at Berenberg Bank in London. More radically, the ECB could start buying stocks or even real estate, as Japan’s central bank has done.
And BofA's Stephen Suttmeier details what to look for in the charts:
EUR/USD - weakness into resistance leans bearish
The last few major technical observations show EUR/USD's trend leans lower. Price made lower highs over the past year, two trend exhaustion signals suggested an end to the rally in February, and now price is failing to break above a short-term trend line that was once support. Price action failed at the 200d moving average and resulted in two doji candlesthis week, showing that neither bulls nor bears took control.
EUR/GBP: Watch for a short-term head-and-shoulders top
A close below the neckline of .77100 would form a short-term head-and-shoulders top that targets a move down to about .75000. Downside levels to know include the 50d average at .76586, .75440 and .74530. A close above yesterday's high, at .77928, and this top pattern is canceled.
Bund and Gilt 10yr yield lean higher after 'exhaustion'
Bund yields have confirmed the exhaustion suggested by the TD Sequential indicator on the daily and weekly charts by breaking above a short-term resistance line.
Yield is also confirming the rising momentum divergence on the daily chart. A break above the less steep daily trend line creates additional upside targets to .298%, .36% and .42%.
Brent may start to outpace WTI
Front-month continuous Brent oil prices are breaking above a resistance line, although WTI is lagging behind and has yet to break a similar line. This may be an early sign that the WTI-Brent spread begins to decline toward support provided by a five-year trend line that is aligned with the 200wk moving average.
Tactical bottoms in equities a vote of confidence in ECB
The developing tactical bottoms on the EURO STOXX 50 (SX5E), STOXX Europe 600 (SXXP) and EURO STOXX Banks (SX7E) are a technical guide to how confident Europe's equity market is regarding the ECB and monetary policy. Near-term bottom breakouts would provide a vote of confidence in the ECB, unless indices fail to breakout. Either way,we view bounces as bear-market rallies.
EuroStoxx bounce reminiscent of bear-market behaviour
The tactical bottom or base may not be big enough to usher in a stronger rally for these indices. A decisive breakout above 3055.38-3056.22 on the SX5E would project to 3430, but the falling 200-day MA and downtrend line from last April provide resistance near 3282-3385. In addition, the SX5E was not able to meet its late October tactical bottom breakout target of 3660. This is bear-market bounce behavior and the risk remains for a limited tactical rebound. Important first supports come in at 2932 to 3855-3800.
EuroStoxx Banks (SX7E)
The SX7E did not breakout with the SX5E and SXXP in late October. Banks make up 14% of the SX5E and 10% of the SXXP, so it is important for the SX7E to confirm any upside breakouts in the SX5E and SXXP. A positive sign for the SX7E would be a decisive move above 109.59-110.68 (with additional confirmation from a move above the daily Ichimoku cloud), which would project to 132. However, the larger downtrend from July remains intact and prior support, at 122-126, could limit upside. Support at 103-100. This is bear-market bounce behavior and the risk remains for a limited tactical rebound. Important first supports come in at 332 to 320-318.
Perhaps even more prescient are the two huge gaps that will inevitably be filled (via Geneve Swisss Bank)
And finally, don't forget that THIS is not fixed yet...
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In summary - Bunds are pricing in a 30bps rate cut, economist expect 10bps... Draghi will disappoint; and if he raises QE, markets will instanly front-run it forcing yields lower and making even more of them ineligible... Good Luck Mario!