The latest monthly ECB meeting is this afternoon is the last for 2014 and the last one for six weeks (from 2015 the meetings will move to every 6 weeks in a similar fashion to the Federal Reserve, with the next meeting penned in for 22nd January). In recent meetings, the run up has been dominated by the “will they, won’t they” engage in full blown QE, in other words the purchase of Eurozone sovereign debt. With the Eurozone languishing with high unemployment (currently 11.5%), persistent low inflation (just dipped back to +0.3%) and low growth, the panacea is perceived to be the ECB’s big bazooka. However, what are the chances of Mario Draghi declaring that the ECB is ready to play its final card? Also what would be the impact if he holds off once more?
The market is clearly positioned for QE. Sovereign debt yields are at record low levels, whilst equity markets have been pushed close to record highs again. Draghi and fellow doves on the ECB’s Governing Council such as Vitor Constancio and Benoit Coeure have been hinting at moves towards QE in recent weeks. Draghi has talked previously about the expansion of the balance sheet of back to mid-2012 levels which would involve the purchase of around €1 trillion worth of assets.
However there are several reasons to suggest that the ECB will not either be willing or able to engage QE at least until early 2015. Firstly, the ECB will want to see how recent easing actions are progressing. The covered bond purchases and asset backed securities will need time to be effective, whilst the second tranche of the TLTRO is on 11th December. Furthermore, noises coming out of Germany from Jens Weidmann (President of the Bundesbank) and Wolfgang Schaeuble (German Finance Minister) continue to suggest they are not supportive of QE at this stage, instead advocating significant structural changes within the Eurozone.
This means that the ECB is unlikely to announce QE today. Instead therefore, Draghi has got a job on his hands so as to not disappoint the market too much. Therefore he is likely to talk once more about balance sheet expansion (again setting the market up for QE), whilst if the ECB staff projections show cuts to the inflation and gorwth outlook further out into 2016/2017 then this will also be seen as a dovish signal.
Draghi needs to show the ECB is getting ready to act otherwise he is running the risk of all talk and no action. This would result in a spike higher in the euro, whilst also could induce a profit-taking correction in equities (the DAX is just 28 points off its all time high currently).
The breakdown in the euro yesterday below $1.2357 points once more towards a market preparing for a dovish outlook from Draghi. With a combination of a weak euro (from a dovish ECB) and a strong US dollar (perception of the Fed now possibly being the first major central bank to tighten) means that EUR/USD should continue to weaken. Ultimately I see the euro testing the $1.2040 low over the coming weeks, however a near term spike higher on a disappointment today could give an opportunity to sell at higher levels.
The 4 hour chart of EUR/USD above shows that there is an ideal “sell zone” of around 90 pips between $1.2357/$1.2450 that could be filled on a disappointment from Mario Draghi today. This would represent a good opportunity to get short on the euro which is likely to continue moving lower over the coming weeks.