Dollar Mixed Ahead of ECB Decision

Dollar Mixed Ahead of ECB Decision

  • Many observers expect a dovish tilt as Draghi prepares to expand QE in December
  • We feel that today’s ECB meeting is still too early in the process to expect an agreement on further action
  • UK retail sales for September were considerably stronger than expected
  • The Brazilian central bank made an important change in the statement after last night’s monetary policy meeting
  • Poland central bank releases its minutes; Mexico reports mid-October CPI

Price action:  The dollar is mixed against the majors ahead of the ECB decision.  The Kiwi and sterling are outperforming, while the Swiss franc and the euro are underperforming.  The euro is trading softer near $1.13 as markets await the outcome of the ECB meeting.  Sterling is trading firmer after strong UK retail sales data, but has been unable to break above $1.55 and is currently trading near $1.5450.  Dollar/yen is still trying to make a decisive break above the 120 level.  EM currencies are mixed too.  IDR and RUB are outperforming, while KRW and ZAR are underperforming.  MSCI Asia Pacific fell 0.3%, with the Nikkei down 0.6%.  China markets were higher, with the Shanghai Composite up 1.5% and the Shenzen Composite up nearly 4%.  The Dow Jones Euro Stoxx 600 is flat near midday, while S&P futures are pointing to a lower open.  The 10-year UST yield is up 2 bp to 2.04%, while European bond markets are mostly softer.  Commodity prices are mixed, with oil up around 1%.

  • The main event today is the ECB meeting.  Many observers expect a dovish tilt as Draghi prepares to possibly expand QE at the next meeting on December 3.  A Bloomberg survey conducted last week found that 80% of economists expect the ECB to eventually do so, with 56% expecting it at the December 3 meeting.  The survey found 86% expect a move by the end of Q1 2016.  Every central bank that has tried QE has had to do more than initially anticipated.
  • Although the ECB has introduced a formal voting mechanism, the institution still seems to be driven by consensus.  Such a consensus does not exist presently.  Nearly every official that has addressed the topic appears to be in a “watch and wait” mode.  Another input is the survey of professional forecasts, which will be released tomorrow.  A downgrade of growth and inflation forecasts could fan expectations that the ECB’s staff revises its forecasts lower in December.  The change in expected economic outcomes is a necessary precondition to changing policy. With the euro’s upside momentum stalling in front of $1.15 last week, the market has found it difficult to rebuild it ahead of the ECB’s meeting today.
  • As previously discussed, there are three broad ways that the asset purchase program can eventually be tweaked.

1.  An extension to the current program, which has a soft deadline of September 2016, can be announced.  This seems to be among the favorite scenarios among investors.  There has been some talk about a six-month extension.

2.  The amount of assets being bought can be increased.  There is a certain logic to this.  If the amount is increased, then there may not be a need to extend the duration of the buying.  Increasing the duration of the program represents a longer commitment but not necessarily a more effective operation.

3.  The composition of what is being purchased can be altered.  The asset-backed purchases have not been particularly successful.  A more aggressive program could include bank bonds or corporate bonds.

  • The ECB could also cut the negative deposit rate from its current -20 bp.  Given that the current rules prohibit buying government bonds with a lower yield than the deposit rate, this would also increase the assets available to it.   A more negative deposit rate may also have a greater immediate impact on the euro, whose appreciation on a trade-weighted basis does the central bank’s efforts to resist lowflation/deflation no favors.  It could also be a compromise between those who want to do more and those who are skeptical of the merits of QE in the first place.
  • UK retail sales for September were considerably stronger than expected.  Headline sales rose 1.9% m/m vs. 0.4% expected, while sales ex-auto fuel rose 1.7% m/m vs. 0.4% expected.  Sales were boosted by the Rugby World Cup hosted by England.  Sterling has been struggling as soft data recently has pushed out market expectations for BOE liftoff, but today’s data has moved it back to the top of its recent narrow range of $1.54-1.55 that has held since the middle of the month.
  • According to the weekly MOF flow data, foreign investors continued to sell Japanese stocks in the week through October 16.  In the last 19 weeks, foreign investors have been net buyers only in four weeks.  Over this selling spree, they have sold JY4.8 trln, roughly $40 bln.  In the prior 19-week period, foreign investors bought JY5.47 trln, around $45.6 bln.  Note that the BOJ continues to buy equity ETFs, but the pension funds that have been diversifying away from JGBs toward equities and international assets are thought to have completed or nearly completed such efforts.
  • During the North American session, the US reports weekly jobless claims for the BLS survey week, as well as September existing home sales and leading index.  The pre-FOMC embargo on Fed official speaking engagements has now gone into effect, and so markets will get nothing from the Fed until the October 28 meeting.  While nothing is expected then, we still believe the December 16 meeting remains live.  We will see two more jobs reports before that.
  • Canada reports August retail sales, expected to rise 0.1% m/m vs. 0.5% in July.  Even though the BOC left rates steady yesterday, CAD weakened after the bank downgraded its growth forecasts.  The 1.3140 high from yesterday represents the 50% retracement objective of the September-October fall, while the 62% objective comes in near 1.3220.  Break above that would target the September higher near 1.3460.  Markets will likely be particularly sensitive to weaker data ahead.
  • The Brazilian central bank made an important change in the statement after last night’s monetary policy meeting.  After keeping rates on hold at 14.25% as expected, it replaced the language on inflation convergence to the target “by year-end 2016” with “within the relevant forecast horizon for monetary policy.”  We think this is a signal that they have no intentions of hiking rates – unless we get a material shock to inflation or FX, of course.  But even then the bar is high.  We think that any unwanted currency weakness will still be dealt with by using FX-related tool, including spot intervention if needed.
  • Poland central bank releases its minutes.  The central bank has been on hold since its last 25 bp cut to 1.5% back in March.  Deflation risks remain high, with CPI at -0.8% y/y in September.  If the economy continues to slow, we would not rule out resumption in the easing cycle.  However, this may be more of a 2016 story, when most of the MPC will be replaced as their terms end.  EUR/PLN is trading at its highest level today since January 22.  The year’s high near 4.3360 from January is nearing, and after that is the December high near 4.40.  Law & Justice official said the party favors rate-cut proponents for the MPC.  These sorts of stories and comments are making markets nervous about policy risks.
  • Mexico reports mid-October CPI, with headline inflation expected at 2.52% y/y vs. 2.53% in mid-September.  With inflation well below the 3% target, the central bank is finding it hard to justify its tightening bias from earlier this year.