Draghi’s Christmas present revealed

All I see this morning is the word ‘euphoria’ (bad news is good news), as Mario Draghi and his elves at the European Central Bank (ECB) practically confirmed there will be an early Christmas present for the European economy on 3 December. 

Mario Draghi
Source: Bloomberg

European stimulus

In Mario Draghi’s prepared statement and press conference, he signalled very clearly that the governing council has moved to a position where further easing policy is a highly likely scenario, with December being the clearest time for this to happen.

EUR/USD tanked on the news. This will be a relief for European exporters considering that when the EUR gets above $1.12, the leaders of France and Germany start feeling slightly uneasy. At $1.14, Francois Hollande and Angela Merkel would be standing next to each other demanding the euro depreciate.

However, the 2% decline overnight to $1.1103 may be short-lived. This time next week when the Fed’s October meeting wraps up, the dot plots are released and it suggests a December hike is off the table, EUR/USD will shift higher, forcing Mr Draghi’s hand.

Expectations are now for Mario Draghi to announce a ‘prolonged period’ (possibly even undefined) of the asset purchase program, likely to be well in to 2017 from the September 2016 cut off.

What is really attracting my attention is that according to the EONIA six-month futures (April futures), it is now pricing in a deposit rate 24.4 basis points lower than the current price (19 basis points before the meeting). That means the market is pricing a cut of 25 basis points to deposit rate to -30 basis points – a very meaningful cut if it comes to fruition.

In short, all options are on the table for the ECB, also meaning that the Bank of Japan (BoJ) and the Fed are now live events as well as the push-pull of global trade (ie currency wars) which creates a void in currency pricing.

Back to Australia

The Commonwealth Bank of Australia (CBA) finally put Westpac out of its misery and hiked rates by 15 basis points across the board. The moves saw the AUD lose half a cent from 72.3 to 71.8 instantly; the interbank market for December was most affected by the news, with expectations of a 25 basis point cut on 1 December jumping back above a 50% to 56% chance.

CBA’s move will all but lock in National Australia Bank (NAB) and Australia and New Zealand Banking Group (ANZ) at next week’s full-year numbers to hike rates as well. However, ANZ may still act alone. It may not move rates higher but will not pass on a cut to the cash rate if it happens in the future.

This ‘out-of-cycle’ move by the banks was actually forecasted by several speeches Glenn Stevens made in July. He foreshadowed that the current funding to lending mix would likely force the banks to act – and he has been proven right. This does give him some scope to move into the future, however it certainly doesn’t guarantee it.

Devil’s advocates point to the hike. Australia has a frothy housing market, confidence is still pessimistic, growth is below trend and there is belief that things will slide further in 2016.

If the lending market was the bond market, yields would be much higher. The banks are making the argument that current interest rates on offer do not reflect the risk they are having to take – in short they are not being paid enough for the risk on offer.

Mario Draghi’s Christmas present is a global present. The ASX is pointing higher by 88 points to 5351 – the highest level since the second leg down in mid-August and now within 40 points of breaking even for the year.

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