Thoughts on the ECB

While there wasn’t anything truly surprising out of Draghi’s press conference today, his stance was perhaps more dovish than expected and confirmed that the door is wide open for action at the December 3 meeting.

In fact, he revealed that some members wanted more stimuli as early as today. All in all, it looks like the ECB is well on the way to building the necessary consensus to move at the next meeting.

Some dovish sound bites included emphasising the downside risks to growth, in part coming from emerging markets and commodities. He also noted that the recovery in the euro-area is being hampered by sluggish structural reforms, and emphasized that monetary policy alone can’t address structural issues.

As expected, Draghi said QE “can be adjusted in size, composition, duration.” But at least based on his comments today, the emphasis seemed to have been on discussions of a cut in deposit rates. Either way, the comments were unambiguous in suggesting that the ECB has the finger on the trigger.

The market reaction went according to the script. The euro fell from $1.1350 to $1.1160, breaking both the 50- and 100-day moving averages, in the largest move since August in percent terms. German bund yields fell, with the 2-year yield at a record -0.316% and the 10-year yield at 0.517%. EuroStoxx has added nearly 1.5%, led by the DAX gaining nearly 2%.

It’s worth noting that the post-September 3 ECB meeting low for the euro was near $1.1085. Today alone, we’ve blasted through the 50% and 62% retracement objectives of the September-October bounce, and the euro has now retraced over 75% of that move. Test of that September low should be seen soon. Looking further ahead, break below the $1.1180 area sets up a test of the August 5 low near $1.0850.

The overarching strong dollar theme remains in play. As we have noted before, the dollar rally rests on two legs. The first leg was driven by central banks outside of the US easing policy. That is clearly ongoing, as this ECB meeting underscored. And with today’s developments, speculation of further easing by the Scandie and Swiss central banks (and others) will likely pick up.

The second leg is driven by expectations of Fed tightening. That notion was pushed back with recent softness in the US data as well as heightened Fed concerns about China, but we continue to believe that the timing itself is not that vital. Whether the Fed lift-off begins in December or January or March, the direction seems clear even if the timing is not.

We note that US initial jobless claims were reported today at a better than expected at 259k. The 4-week moving average fell to a cycle low of 263k. More importantly, this claims data is for the BLS survey week, so this will hopefully translate into a good NFP reading for October when the data is reported November 6.

Indeed, the Fed will see two fresh jobs readings before the December 16 meeting. No one in the market really sees the October 28 meeting as live. However, if the US economy can gain some traction, we think that the markets will reassess the chances for a December lift-off higher.