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EURUSD Isn't the Only Market Facing the Calm Before the ECB Storm

EURUSD Isn't the Only Market Facing the Calm Before the ECB Storm

2019-09-11 04:01:00
John Kicklighter, Chief Currency Strategist
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EURUSD Talking Points:

  • The US Dollar opened the week with its third, large bullish gap in a month, but the previous charges will prove difficult to replicate
  • A run of growth-related data and mix of trade war headlines wouldn't tear investors' anticipation away from Thursday's ECB rate decision
  • Reversals from the Pound, EURCHF and Gold all tap systemic interests, but their progress will prove just as unreliable as the Dollar's

See what live coverage is scheduled to cover key event risk for the FX and capital markets on the DailyFX Webinar Calendar.

You are Now Entering the Loaded-Calm Before the ECB Decision

Of the top three themes that I am currently affording the greatest weight for fundamental influence - and thereby market activity - monetary policy is clearly the most pressing for global markets. The European Central Bank (ECB) rate decision Thursday is now just a day away, and the implications of this important policy gathering are drawing closer scrutiny owing to its proximity. The probabilities of further accommodation priced in by the market are reflecting certainty that at least a rate cut is on tap. However, the buoyancy in European indices and other capital markets as well as the further dive from EURUSD would suggest that much more is discounted. That can prove difficult to live up to - and perhaps they won't even attempt to best those aggressive expectations and sacrifice their credibility in the meantime. This past session there were reports from 'sources' that the group may hold back from QE, merely keeping it open as an option in a bid of plying leverage from its more traditional tool of benchmark rates.

EURUSD Isn't the Only Market Facing the Calm Before the ECB Storm

It isn't clear how shocked the markets would be should the central bank's efforts come up short of the lofty expectations. The DAX, FTSE MIB, CAC 40 and other local capital market benchmarks have rallied lately, but that is inline with most other regions' speculative performance - and it still significantly lags the climb in the US markets. The Euro has slide further these past weeks, but it doesn't seem to have spurred the same preemptive view of impending policy doom that we saw in 2014 from EURUSD when the pair collapsed in anticipation of the eventual negative rate and stimulus policies that are now in place. While the exchange rate is not collapsing at the same clip in the current lead up, these markets are still very likely pricing extreme expectations. That makes it difficult to live up to the dovish anticipation, which holds clear implications for EURUSD along with general market performance itself.

Chart of EURUSD and 20-Week Average True Range (Weekly)

EURUSD Isn't the Only Market Facing the Calm Before the ECB Storm

Chart Created on Tradingview Platform

Risk Trends Have Far Too Much Vested into Monetary Policy to Avoid Blowback

In assessing what kind of impact we should expect from the ECB rate decision tomorrow, it is important to understand that this is not just a Euro or European event. There is a broad currency market consideration that could generate considerable volatility through most major (and perhaps even emerging market) FX. This central bank is vying for the title of the most dovish of the principle policy authorities. While the Bank of Japan has never wavered from its open-ended stimulus effort, its European counterpart has dropped its key rate into negative territory while amassing a sizable balance sheet of its own. At the opposite end of the spectrum, we find the Fed who has only raised its benchmark range by just over 200 basis points from its post-recession low - less than half of what it was in 2007 before cuts began. That does not translate into meaningful contrast which would translate into meaningful returns. That is a mix suited for speculative appetite in complacency rather than genuine optimism.

EURUSD Isn't the Only Market Facing the Calm Before the ECB Storm

What the ECB decides as its next policy move will inform investor sentiment that has drawn heavily from external support. In the absence of accelerated growth (a shortfall of monetary policy) unorthodox and temporary measures have compensated. Yet, those short-term accelerants proved to be unintended foundation with all the trappings of dependency and the inevitable diminishing effectiveness. A complete loss in conviction around the capacity of central bank influence could prove catastrophic given its role in market performance the past decade, but when does that belief falter? It would be far more troubling should one of the most dovish central banks lose control of market lift in the middle of full capitulation rather than a group like the Fed underwhelming with a policy decision given it has far more room to maneuver.

Chart of S&P 500 and Major Central Banks Balance Sheets (Monthly)

EURUSD Isn't the Only Market Facing the Calm Before the ECB Storm

Keeping Tabs on Growth and Trade War Interests

Over the next 24 hours, it will be very difficult to wrest traders eyes away from the implications of monetary policy on economic and financial performance. And, more likely, the theme will keep its influence through the subsequent week with further policy decisions anchored by none other than the Federal Reserve next Wednesday. Yet, that does not mean that the other high-level fundamental themes are simply due to be frozen against fundamental developments. Trade wars continue to register data with a fairly uniform reflection of the pain that continues to build in the backdrop. This past session, SCMP reported Chinese officials were ready to increase US agricultural goods purchases to encourage compromise while credit rating agency Fitch issued a fresh warning over the outlook with the deterioration of trade as a key concern.

An equally relentless concern on the grand scale is the deterioration in the outlook for economic activity. We registered a few indicators this past session that carried growth credits: Japanese tool orders dropped 37 percent and the NFIB US small business sentiment survey dropped more quickly than expected with a 103.5 reading. These are not enough apparently to move the needle however, nor will the Japanese 3Q business sentiment survey or Chinese foreign direct investment figure ahead. That said, we have seen interest/fear over a recession balloon over the past weeks. This is evident in sentiment surveys across the global and economic spectrum, but what has struck me most lately is the search volume on 'recession' via Google, the world's most heavily used browser. We haven't seen this much traffic on this troubling outlook since the Great Recession.

EURUSD Isn't the Only Market Facing the Calm Before the ECB Storm

Pound's Recovery Is Falling Apart While Oil Weighs Supply and Demand Shocks

As we await next catalysts, it is difficult to muster enough conviction to drive assets directly in the radius of the ECB's or Fed's influence - and that is admittedly the bulk of the global markets. Yet there are still alternative fundamental means to follow to volatility. One of the more persistent and frustrating sparks lately has been Brexit. With Parliament prorogued (suspended) for five weeks, we could have seen an extended period without in-fighting leveraging uncertainty behind the Sterling which could have led to a complacent bid. Instead, tension will remain high throughout this unusual break thanks to Prime Minister Boris Johnson vowing to push forward with a possible no-deal outcome should his demands not be met at the EU negotiation table - regardless of Parliament's recent law requiring him to request an extension if an alternative deal is not struck mid next month.

Chart of GBPUSD (Daily)

EURUSD Isn't the Only Market Facing the Calm Before the ECB Storm

Chart Created on Tradingview Platform

Another market that has seen volatility work its way into a mature congestion pattern is crude oil. It is proving difficult to meaningful charge this commodity these past months as the traditional supply-side OPEC updates have garnered less and less response from the energy market. Nevertheless, an unorthodox curb on output seemed to have been alleviated this past session when US President Donald Trump tweeted that he had fired his National Security Adviser John Bolton. Bolton was a well-known hawk on policing perceived global malfeasance, particularly with the likes of Iran, which offered some relief. Yet, what enthusiasm that may have mustered was checked by the EIA downgrading its outlook for world demand by a hefty 110,000 barrels per day in 2019 - though the 2020 reduction was more modest. Overall, I a keeping closer tabs on global activity and demand as a trend measure for oil.

Chart of US Crude Oil and 50-day Historical Range (Daily)

EURUSD Isn't the Only Market Facing the Calm Before the ECB Storm

Chart Created on Tradingview Platform

If you want to download my Manic-Crisis calendar, you can find the updated file here.

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