ECB To Take The Wait And See Approach

Finally the week’s main event, the ECB monetary policy meeting will dominate today’s proceedings. For most of this week, the EUR (€1.1312) has been contained to a narrow trading range (€1.1300-1.14), perforated by very little, but that could change one way or another this morning, obviously hinging on what Draghi has to say.

The ECB is expected to deliver a dovish message, but to stop short of announcing additional accommodation. Market arguments are compelling for some immediate easing measures to be announced this morning. The Eurozone economy continues to experience sub-par growth and is consistently battling low inflation. These are certainly factors that are not inconsistent to a year ago; however, the single currency is much weaker than last November (€1.2673) and consumer confidence is much higher. Fixed income dealers have priced a +40% chance that QE could be extended by an additional €10b per month.

A communication challenge for Draghi: The market majority is expecting a “wait and see” tone from the ECB, peppered with a few dovish remarks from Draghi directly at the post session press conference. Nevertheless, a prudent ECB president is expected to wait for the Decembers updated staff forecasts to strengthen his argument for any action. With the consensus believing that sufficiently dovish talk will be enough to preserve, or even strengthen, market expectations of further easing down the road could imply that this market will not bare witness to any significant directional damage just yet – speculators may have to wait for the Fed for that. Assuming no move, the doves will be looking to the ECB to provide evidence that they discussed conditions that may warrant additional accommodative moves. They will also hone in on the council members view on the deposit rate.

Investors grow more concerned by global growth: The markets perception of China’s slowdown continues to generate market unease. This fear is supporting the USD, especially against currencies tied to commodity exports (CAD, AUD and NZD), including emerging markets (BRL and RUB). A number of data points over the past two trading sessions have put the market on alert. First Japan, it posted its weakest export growth numbers in 13-months earlier this week (down -3.5% y/y to China). China’s bourses are seeing red. Yesterday, the Bank of Canada (BoC) cut its growth projections, and crude oil supplies remain in ‘glut’ territory.

Bank of Canada leaves rates unchanged and lowers outlook: The CAD (C$1.3135) has lost ground across the board following the BoC rate decision. After leaving rates unchanged (+0.5%), the central bank has lowered its Q4 2015, 2016, and 2017 GDP outlooks. At the post meet press conference, Governor Poloz tried to keep things even-keeled by highlighting the momentum build in the Canadian economy and indicating that it was withstanding the spillover effects of low oil prices. Nevertheless, crude prices falling -2.4% yesterday has not helped the loonie’s cause. The Governor noted that at this point weakness in the CAD has “not been out of line” with historical norms.

Being reluctant may not be good enough for the RBA: Despite standing pat on the last go around (record low +2%), the RBA must be feeling some pressure to take the “ease” route. Aussie policy makers have been reluctant to do more monetary easing out of concern that it could lead to financial instability in the longer term. However, the dovish nature of the ECB, BoJ, BoC, RBI and more, will eventually only compound the RBA’s pressures. Currently, Aussie capital markets are responding to CBA overnight actions. They followed Westpac’s +20bp move by hiking variable mortgage rates by +15bps to help offset the balance sheet impact of higher capital requirements. Investors speculate the RBA would then seek to counteract those steps with a policy easing sometime this year. This has put pressure on the AUD (A$0.7215) in the overnight session.

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