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Daily Commentary 05/03/15

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• EUR weakens ahead of European Central Bank meeting The notable feature of the market yesterday was the euro’s weakness ahead of the ECB meeting today. This suggests to me that the FX market hasn’t yet factored in the full impact of QE, despite the fact that bond yields in the Eurozone have fallen to absurd levels as investors front-run the ECB. Last year, ECB days were the big days for EURUSD – the average range for the pair on the days the ECB met was 0.97%, almost double the 0.57% average daily range for the year as a whole. Most other currencies saw little if any increased volatility (vs USD) on ECB days (except for CHF of course, as it was effectively pegged to EUR). However, for at least the next few months I don’t expect any change in ECB policy and hence I see no reason for any dramatic moves in the currency on ECB days. The ECB is unlikely to expand its QE program until it’s had a chance to judge the program’s success. Nor are they likely to express second thoughts on the program or reduce it until inflation is back up near their target. Thus yesterday’s move suggests a vote of confidence that the ECB’s QE program will at least succeed through weakening the currency. EUR could weaken further today as the ECB is likely to reiterate its pledge to keep QE in place until it has proved successful in raising inflation back to target. Moreover, there’s also the question of whom they’re going to buy the bonds from: probably foreigners, who will then repatriate their money (see below).

• CAD strengthens on Bank of Canada statement The Bank of Canada kept interest rates on hold, as expected, but the tone of the statement was less dovish than anticipated. The Bank said that the risks around the inflation profile are now more balanced and that the current degree of monetary policy stimulus is still appropriate, hinting that they could avoid cutting interest rates at the next meeting as well. USDCAD collapsed at the release but recovered to trade around the support line of 1.2430. The rate is still within a triangle formation and above the key support barrier of 1.2370. In our view, a strong NFP print on Friday is likely to erase Wednesday’s losses and perhaps drive the pair again above 1.2500.

• A mixed market in oil WTI rose yesterday, the third consecutive day of gains, on news that inventories rose only 536,000 barrels in the latest reporting week, vs growth of more than 1mn barrels so far each week this year. The slowdown indicates that US supply is starting to respond to the lower oil prices. In contrast, Brent was down slightly as Saudi Arabia reiterated its pledge not to cut production. Given the difference in the response between profit-driven US producers and less profit-sensitive Middle Eastern producers, we could see the gap between WTI and Brent narrow further.

• What will be the main questions for the ECB today? There will be two main issues today. First, the market will be looking for clarification about the ECB’s quantitative easing program, which is to start this month. Secondly, there will be some interest in the revised economic forecasts, particularly the first forecasts for 2017. Some of the issues we hope to have clarified are:

When exactly will they start buying bonds from the market?

How will they coordinate the purchases, which are supposed to be carried out by the national central banks and not the ECB directly?

They said they will buy EUR 60bn in public and private debt. What are the targets for public sector vs private sector bonds each month? Will they be willing to buy bonds with negative yields to achieve that target?

Whom do they expect to buy the bonds from? About half of the Eurozone sovereign bond markets are held by European banks and financial institutions. They are not likely to sell, for the simple reason that they will have a hard time replacing the assets with anything offering a similar yield. In contrast, an estimated 36% of the bonds are held by foreigners, who may be more willing to take profits and invest the proceeds elsewhere (such as in Treasuries or Gilts). In that case, QE could be distinctly EUR-negative.

What happens if they can’t find enough bonds to buy? Will they be willing for example to buy equities instead, as the Bank of Japan does?

The ECB said the bond purchases will continue “until we see a sustained adjustment in the path of inflation…” What exactly does that mean? How big an adjustment, and how long does it have to be sustained?

ECB Chief Economist Peter Praet recently said that the ECB “sees a turning point” in the Eurozone economy. Will they raise their forecasts as a result? The strength of the economy matters for the success of QE, because banks will only be willing to sell their bonds if they think they will be able to use the money to make loans. Therefore, the stronger the economy, the more successful QE is likely to be.

The 2017 forecasts will be released at this meeting. What’s their expectation for inflation in 2017? Do they think they’ll be back to their target of “below, but close to, 2%” by then?
• The Bank of England also meets to decide on its policy rate. There’s little chance of a change, hence the impact on the market should be minimal, as usual. The minutes of the meeting however should make interesting reading when they are released on 18th of March.

• Today’s indicators: Germany’s factory orders fell by more than expected, -3.9% mom vs expectations of -1.0%. There was no impact on EUR/USD.

• In Sweden, industrial production for January is expected to have slowed from the previous month. This could weaken SEK and drive USDSEK up for a test at the 8.4000 resistance zone.

• From the US, factory orders for January are expected to have risen 0.2% mom, a turnaround from -3.4% mom the previous month. After five consecutive month of drops, even a modest rise in factory orders could be an indication that the US growth has started regaining momentum in Q1 after cooling a bit in Q4, and consequently support the dollar.

• Canada’s Ivey PMI for February is forecast to have risen, but still to stay below the 50 critical level.

• Besides ECB President Draghi, we have speeches from Riksbank Governor Stefan Ingves and Norges Bank Governor Oeystein Olsen.

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