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Later tonight, at 8.45pm SGT, the European Central Bank (ECB) is expected to add to current stimulus measures. Ever since the ECB lowered its forecasts in September, followed by President Draghi’s comments in October, there is no doubt that more easing action is necessary to bring inflation up as quickly as possible to close in on the 2% target.
Interestingly, the prospects of additional stimulus pressed down on the euro, where previously the single unit currency has been quite resilient. EUR/USD depreciated 4% in November, sliding from 1.10 to around 1.05, the third worst decline this year, behind March’s -4.2% and January’s -6.7%. Of course, more conviction from the Federal Reserve concerning its first interest rate hike in nearly 10 years probably contributed to the euro weakness too.
One objective of the ECB’s €1.1 trillion asset purchase programme (APP) is to keep the Euro-zone’s safe haven assets at relatively low rates in order to push portfolio investors into risk assets and other currencies, thereby boosting growth. However, the Bund sell-off in May could have disrupted the planned functioning of this objective. Put differently, the pace of the portfolio rebalancing out of the safe-haven assets into risk assets was too quickly.
At first, it was puzzling that EUR/USD bounced sharply to from 1.05 to 1.14 by May, and at times it briefly tested above 1.15. In hindsight, the Bund sell-off is likely to have pushed Euro zone investors into buying euro, temporarily. From a broader perspective, euro ought to be under pressure, given the loose monetary policy and subdued economic recovery.
Could euro drop further?
The question many are asking is ‘could euro dropped further?’ Certainly, the prospects of parity are still on the horizon. Goldman Sachs expects EUR/USD to drop to near parity in December, and continue in a weakening trend to as low as 0.80 by the end of 2017.
Following an unchanged decision on 22 October, the EUR/USD fell two big figures, as markets priced in a 10 basis point deposit cut, and dropped another one big figure lower a day later as Draghi signalled QE expansion. While economists are expecting a -10bps move tonight, markets are looking closer to -20bps.
This means that the markets may be potentially disappointed if the cut, if any, is less than expected, or if the total easing package is not as aggressive as anticipated. Expectations for the QE programme is an increase of EUR 10 billion per month to EUR 70 billion. Would we see a bounce in EUR/USD if there is a disappointment given the large net short positions in the futures markets.
FX markets are positioned for the ECB to deliver more stimulus, but less stimulus may be a risk that might be overlooked. On the other hand, if the markets feel the inadequate response will threaten the recovery of the Eurozone, we could also see more weakness in the euro.
Meanwhile, the dollar is recouping recent losses, with the dollar index regaining above 100, helped by Fed Yellen’s remarks and solid ADP reading, portending a potentially robust non-farm payrolls print this Friday. This will reinforce the widely-expected view that the rate lift-off will happen in mid-December.
China up but rest of Asia subdued
In Asia, Chinese equities closed higher, led by financials. The CSI 300 financial index rose to a four-month high as the rumour mill makes it run. Traders speculate that the Chinese government will take further steps to bolster growth. But it is any wonder if the upward momentum is going to last, given that the 28 IPO due from now until end of the year is estimated to lock up CNY 3.4 trillion of funds.
Until the government switched to the new system for IPO subscription, abandoning the current pre-funding requirement, which has disrupted liquidity conditions, I will remain cautious on putting bullish bets during IPO periods. Meanwhile, the rest of Asia did not share in China’s optimism, as most regional indices wade in red, including the Hang Seng index. The STI remained in a sideways gait, although it showed picking up after opening down -0.9%.
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