Thoughts from the Forex Trenches
13 Years ago | December 01, 2014 12/11/23, 12:00 AM
In the Decmber Issue
- ECB QE: When, Not If, But?
- Video: Forex Trading Outlook for December, 2014
ECB QE: When, Not If, But?
The reasons for a weaker EURUSD are well documented, an underperforming economy, low inflation bordering on deflation, recent monetary easing and ECB president Draghi holding out the risk of more easing measures if needed (i.e. QE). It is the latter that continues to act like a cloud over the EUR. So the question is if it is a matter of when, not if the ECB undertakes QE but is it legal? I leave the legality to the courts as markets have little choice but to price in the QE risk.
The logic behind expectations of QE is that the ECB will have little choice if it is going to keep its pledge to boost its balance sheet by EUR1 tln. Many see this as a difficult goal without QE as there are not enough assets to buy without purchasing sovereign government bonds. EZ government bonds are betting on it (e.g. record low yields). The forex market sees this as inevitable as well but the timing is difficult to call as it is likely a last resort by the ECB given opposition to QE by many board members.
This sets the stage for the December ECB where the odds of QE still seem slim at this meeting but other easing measures cannot be ruled out as there is a lot of pressure on the central bank to do something. There is thus some risk of a disappointment if no QE is announced but this is likely to be offset by a dovish Draghi. One wild card is whether seasonal influences, which often work against the dollar at this time of year, become a factor as positioning is still very short so something to keep an eye on.
Looking ahead, at some stage markets will demand that Draghi put up or shut up but for now seem content to follow his dovish stance that keeps the EUR on the defensive. These comments from ECB VP Constancio were taken as a sign that QE might be undertaken in the first quarter of 2015.
Comments out of ECB Vice-President Constancio during the European session are the strongest signal yet that the ECB is preparing to start government bond purchases early next year. Constancio said that if current measures fail to bring inflation back to target, the ECB will have to consider buying other assets, including sovereign bonds. A subsequent FT report said that the ECB would likely pursue steps like buying corporate bonds and changing TLTRO conditions before trying sovereign bond QE (Source: TradetheNews.com)
In any case, QE, which I call the nuclear option, will remain on the table no matter how the market reacts after the December ECB meeting and this should continue to place a limit on the EURUSD upside. In this regard, the downside risk will be strong bearish while below 1.25, bearish but less so if between 1.25-1.28 and only 1.30+ would negate thoughts of 1.20. QE, especially if it comes as a surprise by its timing, would quickly put 1.20 and below on the radar.
In the meantime, the debate will be when, not if…
Jay Meisler, founder
Global Traders Association
Forex Trading Outlook for December
