EURUSD Talking Points:
- The ECB announced a 10bp rate cut to -0.50 percent, the restart of asset purchases and tiered rates on excess reserves Thursday
- US President Trump quickly responded to the cut as manipulation and reiterated his belief that the Fed was falling behind
- After 'good will' moves by the US and China in their trade war, reports are percolating that the White House may have found its pain threshold
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EURUSD Responds Dramatically to ECB QE, But Why Did it End Higher?
As expected, the European Central Bank's (ECB) rate decision this past session proved a remarkable market-mover as the market expected - and received - an escalation to extreme monetary policy. Swaps had already fully priced in a 10 bp rate cut to the deposit and rhetoric from a number of the bank's members raised speculation (unfortunately, there is no direct measure for this anticipation) that they would return to stimulus at this meeting. In this sense, the world's second largest central bank met expectations. The policy authority lowered its key rate to -0.50 percent and announced that they would restart asset purchases of 20 billion euros per month via the quantitative easing (QE) channel as of November 1st. The announcement of tiered rates on banks' excess reserves to help combat profitability concerns didn't draw the same speculative interest. This mix could certainly compete for the world's most dovish major central bank, but EURJPY's advance would suggest the market isn't ready to afford that title.
Chart of EURJPY and 50-day Moving Average (Daily)
Chart Created on Tradingview Platform
Yet, more than the jump in the Euro against another currency backed by an 'open-ended' stimulus program (the Yen by the BOJ's QE), the Euro would even end this past session higher against the US Dollar which sits on the opposite end of the monetary policy spectrum amongst the major groups. Initially, EURUSD dove on the announcement of the policy changes. While it would close in on the low set at the turn of the month, it didn't overtake. Instead, a bid took traction and spurred a strong reversal from this pair that would eventually see it close a significant gain on the day and over the week. This would turn out to be an extraordinary surge in volatility with the day's range relative to the past month at levels not seen since June 14th, 2018 which was charged by the ECB's signal that it would cap QE 6 months forward. Further, the 'wick' that we were left with on the daily candle signaled the biggest such bullish reversal since January 2017.
Chart of EURUSD and 20-day Moving Average with ‘Bullish Wicks’ (Daily)
Chart Created on Tradingview Platform
While this past session showed a remarkable about face and incredible volatility, the fundamentals for a pair like EURUSD should be considered before we root any serious conviction. The market had certainly discounted a significant escalation in easing, which this wave of effort seemingly met or fell short of which thereby took off the speculative edge. That said, such extraordinary effort is still bearish to the currency. We must separate the assessment of relief rally from that of genuine reversal intent. We have the former, but the latter would require a legitimately favorable turn for the Euro (which this wasn't) or corroboration with the counterpart. On that front, the Dollar could acquiesce.
Chart of EURUSD and 20-day Moving Average with Ratio of 1-Day to 20-Day ATR (Daily)
Chart Created on Tradingview Platform
Risk Trends and Fed Pressure After ECB
The further distension of monetary policy makes for interesting pairings when we consider the Euro on its own. EURUSD for example has to take into consideration the tempo of the Fed's easing monetary policy going forward, which makes for considerable uncertainty ahead of next week's Federal Open Market Committee (FOMC) meeting. If the Euro is genuinely due a lift from a depressed position, a pair like EURCHF would be more appropriate given that the Swiss National Bank (SNB) determines its monetary policy with explicit consideration as to what the ECB is doing. Yet, this relative perspective is not the extent of the European authority's influence moving forward.
Chart of EURCHF and 50-Day Moving Average (Daily)
Chart Created on Tradingview Platform
As expected, the ECB's further easing Thursday was noticed by US President Donald Trump. Having already repeatedly critiqued the foreign central bank's policies directly and as a means to hit at the Federal Reserve, seeing his Tweet soon after the escalation shouldn't have been a surprise. He remarked that the group was "trying, and succeeding, in depreciating Euro" which is a blunt accusation of currency manipulation by most leaders' standards that in turn would be used as justification for retaliation - in other words a currency war. Yet, thus far, Trump seems to be using the observations as pressure to force the Fed into a monetary policy fight. He accused the group of dragging its feet following his suggestion Wednesday that the group should cut rates to zero or negative. The Fed can continue to ignore the pressure from the White House, but the growing divergence between their policy standing and that of the second (ECB) and third (BOJ) largest central banks is not as easily written off. How the Fed - as well as the BOJ and SNB - factor in this latest effort next week has become much more important.
The disparity of monetary policy among the world's largest developed economies is increasingly a consideration for fundamental risk trends. Is stimulus a necessary girder for growth and stable markets going forward? If so, the central banks that are not acting now could invite trouble. Otherwise, the active dive into ever more extreme stimulus is distortion that is rendering limited economic return while artificially inflated capital market assets. That latter concern is one that was either chided or completely ignored just a year ago. Today, on the other hand, even the central banks themselves are warning that their ability to afford favorable change is flagging while their concerns of 'cost' to extreme policies are coming up more frequently. If the markets-at-large were to decide tomorrow that monetary policy was no longer capable of keeping the peace - much less provide further speculative lift - what would happen to the markets?
Will the White House Ease Trade Wars as It Feels the Economic Pressure?
We are currently in a lull between significant monetary policy swells. Next week's run of central bank decisions - four developed world giants and two large emerging market authorities - will draw our expectations and then tax the market's bid to keep steady. Yet, fundamental interest will not be completely isolated to the realm of central bank action and rhetoric. The other major fundamental themes stirring volatility these past months will still hold the capacity to spark volatility and even trend. Trade wars in particular is of interest. Following reciprocal moves of 'good will' by China and the US - a waiver on 16 US imports and two-week delay on escalating the tariff rate on $250 billion in Chinese imports from 25 to 30 percent respectively - the market is tentatively evaluating a roadmap that could lead to a u-turn in trade wars.
Chart of USDCNH and 50-Day Moving Average (Daily)
Chart Created on Tradingview Platform
Skepticism over genuine intent at this stage is understandable given the repeated false dawns in trade relations. However, political motivations may prove more effective than anything we have seen to this point in 18 months of economic warfare. This past session, one of the President's advisers repeated the story that Trump would not cut a quick deal as he is holding out for the long-term objectives, and a delay by China it was intimated would only make their situation worse. Alternatively, it was reported that some of his top advisers - Lighthizer, Mnuchin, Kudlow - have warned privately that pursuing tariffs above $250 billion on Chinese imports would raise more acutely the costs to the US economy. As sentiment polls show growing fear of recession across consumer, business, economist and investor; the risk of an economic swoon rises...and in the lead up to the Presidential election. The pressure the President is heaping on the Fed is likely a means to find relief from pain partially brought on by the trade wars. If the monetary policy group doesn't move fast or aggressively enough, will the administration pullback on its commitment to change China's habits? The markets certainly seem to think so.
Another Step in Brexit Drama
Outside of the distinct spheres of influence on the systemic level, we still have discreet fundamental developments that are driving particular currencies or regions. The Brexit drama continues to play out for example. Following the suspension of Parliament by Prime Minister Boris Johnson and a Scottish high court's ruling that the move was illegal earlier this week, we were receiving a run of reports Thursday that show the pressure is mounting to a possible breaking point. With a backdrop of economic fallout defined by the release of the 'Operation Yellowhammer' assessment in the worst-case scenario 'no-deal' outcome, EU chief negotiator Michelle Barnier said there were no grounds to re-open Brexit talks; but it was also leaked that the EU Parliament was ready to extend an extension to negotiations to the country. What was more interesting - and equally unconfirmed - were reports that Johnson's own cabinet members were urging he seek an extension rather than break the law. Sterling doesn't seem ready to make a decision.
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