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Has the ECB lost credibility from the market

If central banks have been our support mechanism for the past six years then we have probably hit a point where this support is in part dissipating and almost certainly now factored in.

Mario Draghi
Source: Bloomberg

That seems to be the case now with the European Central Bank (ECB), who undoubtedly have lost some credibility, or at least that is the line from most economists who were all calling for a shock and awe type of approach. One question that was raised is why Mario Draghi didn’t try and water down expectations somewhat in one of his recent speeches throughout November.

Did he not expect such strong German opposition? We are left with a market that is now of the belief that we are unlikely to see further easing and one that is fully schooled in understanding positioning and expectations and that when a central bank fails to live up to expectations the reaction can be violent.

Traders will almost certainly think twice about holding a strong consensus position into a major announcement from here.

We have seen a number of traders fading the huge rally in EUR/AUD and EUR/NZD. The belief is that once the dust settles, traders will look again at the EUR as the pre-eminent funding currency and marry that with a higher yielder. EUR/USD is the tougher trade, as we have the US payrolls in play in the coming session and a weak number could cause some further volatility, although one finds it hard to feel it will disrupt the notion of a December rate hike by the Federal Reserve.

A weak number (say below 150,000 jobs) should be seen for what it is though; bad for equities and we have to move on from the idea that lower for longer is actually a good thing.

I still favour a lower EUR/USD over the medium-term, but am sceptical of selling now and would be keen to wait for volatility to fall. Volatility is the key behind carry structures in both the equity and FX markets, and should be a core input for trading and investment plans. The 50% retracement of the 8.5% sell-off at $1.1010 seems like a more compelling place to work offers in my opinion.

European equities took a bath yesterday and our opening call suggests more pain, although the pace of losses (at least on the open) has abated. The European financial conditions have deteriorated sharply as a result of the moves in fixed income, equities and the EUR, so it promises to be a very telling session.

Will the ECB induced sell-off be a one day affair, or is this likely to steam roll into something more sinister? Mario Draghi would clearly not be happy about the reaction, but that is the end result for over promising and we, as traders, are always used to the equity markets rallying in the wake of his post meeting speech. This is unchartered territory for many.

Asian markets have provided no support either. Although if I can find a positive, it’s that S&P 500 futures are starting to edge higher. The ASX 200 has seen strong sellers of the recently in vogue hunt for yield, with the financial sector having rallied some 8% since mid-November.

The unwind of the yield trade has seen the banks down over 2% and taking a large percentage of the points out of the market. Volumes have been quite impressive and although we’ve seen some stability 89% of stocks are still lower on the day.

Even energy stocks are lower despite a strong bid in oil and perhaps equity traders are not expecting too much from today’s OPEC meeting. My own view here is that traders purely holding long positions in oil in anticipation of a cut to production quotas could well be disappointed and they will clearly need the likes of Iran to be full compliant. That is a slim prospect at best.

Cuts would need full agreement from the group and there is even some discussion of incorporating non-OPEC countries (such as Russia) and that again seems very low in my opinion. Still, oil clearly has been moving in a positive fashion on the day and I would personally be looking much more closely at the urgency heard in any rhetoric.

Any increased signs of stress around the falls in Brent could mean that we may see a continuation rally. Recalled in June, the group were ‘100% satisfied’ with the oil moves. Brent prices are some 30% lower from here and I am guessing most OPEC members are hurting fairly badly now.

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