Euro weakness ramps up ahead of the ECB meeting

Just as it seemed markets were in cruise control and investors were looking to start positioning heading into next week’s European Central Bank (ECB) meeting, the Swiss National Bank (SNB) crashed the party.

Source: Bloomberg

The unprecedented move sent global markets into a spin with volatility rampant in the fx space. In a nutshell, the SNB has removed the peg on EUR/CHF, which was at 1.2000. In turn they have lowered the interest rate on large deposits to -0.75% (from -0.25%). This resulted in significant Swiss franc strength, with EUR/CHF dropping well below parity. While the strength of the Swiss franc on the back of the SNB’s surprise move has been well documented, I feel the impact this has had on the euro will be a key point of focus on markets going forward.

  1. The SNB’s balance sheet had ballooned over the years, making up 85% of GDP. Having sat on the bid side of the euro for all these years and with the euro likely to continue depreciating due to policy divergence, particularly against the greenback, then the process of maintaining the peg was becoming unsustainable for the SNB. This latest central bank move has led me to a number of conclusions which are likely to be in focus over coming months.
  2. Central banks will be the key drivers of price action and trading strategies this year, given the precarious condition the global economy is in. There is a lot of pressure on central banks to act in a bid to protect their own economies and this is likely to lead to a lot of unpredictable moves, such as that we saw yesterday. Many market participants have aired concerns about the lack of warning from the SNB, given central banks are usually somewhat predictable in their actions. To put it into perspective, the Vice President of the SNB said ‘the floor must remain the pillar of our monetary policy’ just last week. Regardless of what the central bank moves are, playing the divergence between central bank policies will be key for fx markets this year.
  3. ECB stimulus is most likely on the way after receiving the green light from the European Court of Justice to announce a quantitative easing (QE) program at its next central bank meeting on 22 January. The impact of this would have been further euro weakness and this would have meant the SNB had to step up its efforts on the euro bid in order to maintain the peg. The fact the ruling was favourable could have been a trigger for the SNB to pull the pin on the floor and look at alternative measures. As a result, the SNB effectively told markets indirectly that it believes QE is on its way.
  4. In that case, the euro is likely to continue weakening with the ECB likely to keep increasing the size of their asset purchases throughout 2015. EUR/USD will continue to be eyed for shorts and I feel any strength will be used as an opportunity for fresh shorts. Another interesting pair to watch at the moment will be EUR/JPY which is experiencing some interesting fundamentals as the yen benefits from safe haven flows. This pair has dropped significantly over the past week and this trend could continue in the near term in which case traders can look at momentum plays.

Outside of fx, traders have to look at European equities as this QE programme will bring opportunities in abundance. While we are likely to see a pullback in European equities today with our current opening calls pointing lower, the medium term picture looks positive and is likely to be supported by asset purchases in a similar way to what we saw in US markets. The DAX remains my top pick given a lot of factors are working in favour of the German economy. Several factors could work in favour of Germany starting with the weaker euro, net inflow into bunds and weaker commodity prices. Its big manufacturing base is likely to benefit from all these factors with exports ramping up. Additionally we have the SNB encouraging capital outflow to keep the CHF weak and not to mention repatriation benefits for Germany as the CHF strengthens.

Looking around Asia, it’s mainly risk off today with the Nikkei leading losses after the yen strengthened on the back of the SNB move. China is enjoying some gains but I suspect this could be short lived and equities there are likely to play catch-up at some point. The ASX 200 has been hit hard with the banks lagging and the turmoil in the energy space continuing. In the materials space, there are some bright spots particularly in the gold space as the precious metal benefits from recent turmoil in markets.

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