November FX markets were all about one thing: buying US Dollars. But in a heartbeat this notion has been disrupted by Mario Draghi, who reluctantly or otherwise has not given markets what he and other ECB officials had been hinting at all month.
At the risk of sounding like the proverbial broken record, here was the scenario: The ECB would add aggressive easing early in December, while the Fed would begin its long-awaited tightening program a week later.
So lets’ recap the month that has passed, but in so doing it would be pointless not to mention the events that have unfolded just 3 days into December. The euro dropped to 1.0570 – a loss of 4pct for the month, while almost every single currency pair moved in a similar direction against the USD. One curious exception has been the AUD which managed a 1.5pct gain on better export data, employment growth and inflows from Japanese investors. This seems somewhat out of tune with the continuing concerns and slump in commodity prices – CRB index down another 6.5pct in November-but there it is.
On this theme we note other deflationary signs: Gold down another 7pct, Oil down over 10pct. No bounce on Middle East/terrorist acts and renewed European intervention in Syria, no threat from the Turkish-Russian incident and a continued slump in European yields – German 10 year lost 10bp to 0.46, US 10 yr steady around 2.20.
But let us fast-forward to 3 December, the day that the ECB met to announce policy changes. Going into the announcement, the Euro had traded at 1.0550-a new low since the recent March bottom of 1.0460. However, Mr. Draghi failed to deliver what had been hinted at, namely expanding QE and more than the 10bp cut in the deposit rate. Reaching almost 1.1000, the Euro’s jump was the biggest upside move in 6 years. European bourses were hit hard, while the German 10 yr rose as high as 0.75, not exactly earth-shattering unless you were a leveraged buyer of coupon at the previous level!
Markets now face two further key developments – one that may well influence the other. These are the monthly US employment data which had been unexpectedly strong last month – another catalyst for dollar strength of course. And then the Fed on 16 December. As this is written, there are few that believe that the Fed will hold back this time. Yellen has practically pre-announced a rate hike. But are the markets setting themselves up for more disappointment?
There is a rule in the FX markets which can be ignored only at one’s peril and that is “Never rely on the generosity of the Central Banks”!
So let us take a step back here from all the rhetoric, and as we have said in the past, market anticipation does not seem to fit the global picture. The US economy is continuing to show signs of weakness, particularly in the manufacturing sector and the strong dollar is not helping. While the Fed quite rightly feels the need to begin normalizing monetary policy, is this really the time? Why not wait for further signs of recovery within the Eurozone-which are there, and which clearly weighed on the ECB decision? Why allow the dollar to regain its recent losses?
Assuming that the Fed - to save face if for no other reason - moves in two weeks, market reaction will be focused entirely on the accompanying language and our view is that this will in fact not lead to a stronger dollar, and that the present cycle may be coming to an end, with this week as the first indication.
We cannot close without mentioning the threat to European and other nations’ security because of terrorist action and the response. As horrendous as this situation is for people everywhere, the response in military build-up and spending is an economic and potentially inflationary stimulus. It is far too early to judge its impact but deficit spending is going to be the order of the day, taking precedent over Eurozone statutes. Will European rates actually rise faster than in the U.S?
We wish all readers a Merry Christmas and a safe and happy holiday Season!