Here’s How to Trade the Sept ECB Rate Decision

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The European Central Bank’s monetary policy announcement is the most important event risk on the calendar this week. Aside from the rate decision, the central bank also releases its latest economic projections which helps to shape future policy plans.  ECB President Draghi is expected to remind investors that inflation is low, the economy is weak and easier monetary policy may be needed. Consumer spending has been particularly soft, manufacturing and trade activity took a hit after Brexit and most importantly, inflation remains well below target with year over year core CPI growth slipping to 0.8% from 0.9% in August. However there have also been areas of improvement namely in business confidence, German spending and German stocks.  Some are hoping for more QE but at most we expect the ECB to extend its asset purchase program beyond March 2017.

As usual the EUR/USD there will be different phases to the currency pair’s post ECB reaction.  First, if there is no new QE, EUR/USD will jump. Then the second and more sustained reaction of the day will depend on the ECB’s guidance and their staff forecasts – most likely these will be dovish which means weakness for the euro. However if there is no QE and Draghi stresses that they are in wait and see mode, the gains in EUR/USD will be sustained and of course if there is new QE, EUR/USD will drop to 1.11.

 

Will Aug NFPs Help or Hurt USD/JPY?

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The focus now shifts to the U.S. dollar.  Non-farm payrolls are scheduled for release tomorrow and ahead of this key event there was very little consistency in the performance of the dollar.  The greenback traded lower against JPY, AUD, NZD and CAD but moved higher versus EUR, GBP and CHF.  After the strong increase in June, there’s no doubt that job growth slowed in July and the big question is by how much. Economists are currently calling for job growth around 180K and any reading greater than 200K will be positive for the dollar as long as the unemployment rate improves and average hourly earnings rise as expected.  Any miss in the headline or underlying components will send the dollar tumbling lower.

While the leading indicators for non-farm payrolls point to a decline, the number may not be that bad.  The 4 week moving average of jobless claims declined, continuing claims are lower, Challenger Grey and Christmas reported a sharp drop in job cuts and corporate payrolls increased slightly according to ADP.  Although the employment component of non-manufacturing and manufacturing ISM declined, the dip was small and consistent with the drop in payrolls already forecasted. Consumer confidence is also down marginally according to the Conference Board’s survey, leaving the only major deterioration reported by the University of Michigan.  There’s no doubt that the U.S. economy is outperforming its peers, which should make U.S. assets and the U.S. dollar more attractive in comparison.  For these reasons and the fact that Japan’s big event risks are over, we anticipate a stronger recovery in USD/JPY.

 

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BoE Preview – Rate Cut AND QE?

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Tomorrow’s Bank of England meeting is one of the most important events this month.  Back in July, U.K. policymakers made their plans to ease in August abundantly clear and now that the time has come, sterling has been surprisingly stable.  By giving investors sufficient warning, the market had the opportunity to completely discount a 25bp rate cut and the question now is if the BoE will do more. They could cut interest rates by 50bp or they could combine a quarter point cut with renewed bond buying. Quantitative Easing was a critical part of the BoE’s monetary policy during the financial crisis but with interest rates already so low, the effectiveness of QE is in question. Many economists believe they will revive the program but not this week. Since Britain decided to leave the European Union, the Bank of England has taken major steps to stabilize the financial markets and encourage lending – and so far it has worked!  Stocks are stable, yields have increased and the doomsday sentiment in the market is fading. A lot of this has to do with the U.K. government’s decision to postpone invoking Article 50 for the next year or two, reducing the immediate risk for businesses.   This means the central bank can wait to ease again when there is a greater evidence of a deep contraction in the economy.

Taking a look at the table above, there’s certainly been more deterioration than improvement in the U.K. economy since the July monetary policy meeting. However wages are up, the unemployment rate is down and consumer prices are ticking higher.  Second quarter GDP growth was also better than expected.  Although manufacturing, services and the composite PMI indices fell sharply in July, this morning’s numbers were not revised lower after the flash release.  When the Bank of England releases their Quarterly Inflation Report tomorrow, their forecasts will be grim – policymakers previously warned of a possible recession post Brexit.  Governor Mark Carney won’t have anything positive to say outside of acknowledging financial market stabilization.  Yet economic and financial conditions are not desperate enough for the Bank of England to rekindle their QE program.

In other words, we feel that the Bank of England doesn’t need to send a strong message to the market right now outside of a 25bp rate cut and a stern warning of more easing in the coming months.  If we are right, we could see a bigger short squeeze in GBP/USD that will allow investors to reset their short positions at higher levels.  The U.K. is not out of the woods, as growth will only slow further in the coming months / years because the U.K. government is simply delaying the inevitable.  If they cut by 50bp or restart their bond buying program, sterling will fall quickly and aggressively.

RBA Rate Cut – Not a Done Deal

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The Reserve Bank of Australia also has a monetary policy announcement and the majority of economists surveyed expect the RBA to cut interest rates by 25bp but we feel that a rate cut is not a done deal.  The last time we heard from the RBA they sounded open to the idea of easing if data supports it but since the last meeting in July, manufacturing activity accelerated, consumer prices increased, full time job growth rebounded, business confidence improved and the participation rate is up as shown in the table below. Granted consumer confidence is down and the unemployment rate ticked up, we’re not sure if this is enough for the RBA to pull the trigger on easing in August. The AiG Performance of Manufacturing Index rose to 56.4 vs. 51.8 previous.  Chinese PMI numbers were mixed. The official manufacturing PMI showed a decline from 50 to 49.9. The Caixin Manufacturing PMI reading registered an increase in activity, coming in at 50.6 vs. 48.9 expected. Australia’s trade balance and building approvals report will be released pre-RBA but the rate decision will be key. If the RBA cuts, AUD/USD will drop below 0.75 cents quickly but if they hold rates steady, we should see Monday’s high of 0.7615 recaptured.

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