Notes From Underground: The BOJ and the ECB Provide the Recipe For … ?????

Before I preview the BOJ and ECB I want to expound on the piece that I mentioned in the previous post written by Bloomberg reporter Alexandra Harris, who cites the thoughts of JPMorgan strategists Alex Roever and Kim Harano. The piece lists four arguments for bringing forward the FOMC‘s announcement to shrink its balance sheet:

  1. Economic conditions are supportive of balance sheet run-off;
  2. The vast amount of discussion has already prepared the market and September won’t make it any clearer;
  3. Starting NOW buys a “few extra months” of the measurement of the market impact of normalization;
  4. Finally,September is an “awkward time” because of the murky outlook for addressing the debt limit before funding runs out in October.

I agree with all these arguments and would HOPE the FED announces its intention to start shrinking the balance sheet at next week’s meeting, press conference be damned.

Also, a long-time reader of Notes From Underground raised an important question: If the ECB is still involved in full throttle QE and the Fed is on the verge of QT [Peter Boockvar] why is the DOLLAR WEAK and the EURO RELATIVELY FIRM? This is a very important question and will be discussed as the year proceeds. The discussion in this BLOG since February and the comments from former Ford CEO Mark Fields — who said currency manipulation “is the mother of all trade barriers” — prompted me to shift from a neutral position to being BEARISH the DOLLAR.

If corporate America was pushing a weak DOLLAR position in an effort to promote U.S. trade, it was dangerous to maintain a bullish dollar position. The answer to FE‘s query may be found in a flows argument as European growth was being upgraded while the U.S. remains mired in a morass of political uncertainty. The Trump “agenda” has been held hostage by the embedded bureaucracy of Pax Americana and the buffoonery of Presidential tweets.

The question about DOLLAR weakness will become clearer once some of the political uncertainty clears. The fundamental basis of interest rate differentials can be a determiner of relative currency values, but at these ultra-low levels the policy of financial repression and negative real yields makes this very difficult to measure. BUT IF QT COMMENCES IN THE U.S. and the DOLLAR fails to rally that will provide a signal that investors have other concerns about the United States. This will be a major issue for us to monitor as the summer comes to an end.

***Thursday, the BOJ and the ECB announce their interest rate policy intentions. The BOJ is not expected to change its present policy even though Zero Hedge had a piece suggesting that Governor Kuroda would announce ending the central bank’s inflation targeting policy. I am skeptical about this but if so I would conjecture that the YEN WOULD RALLY because it would provide flexibility for the BOJ to swiftly suspend its QQE program whenever it wished (there would be no TARGET for the ARROW to hit.) The YEN has not had enough of a rally today to suggest any real significance to the ZH piece. The most important aspect of this BOJ meeting is that it will be the last for the board’s two dissenters and they will be replaced by Goshi Kataoka and Hitoshi Suzuki, who are projected to be more amenable to the views of Governor Kuroda. The BOJ seems to be content with its QQE policy and the relative weakness of the yen versus many currencies should result in maintaining the current policy.

The ECB announces at 6:45 a.m. CDT and, as usual, President Draghi holds a press conference at 7:45. Some analysts are predicting a conversation about the ECB tapering but it will not be TOMORROW. In April I conjectured that Mario Draghi would prefer a stronger EURO heading into the September German elections so as to keep the Bundesbank at bay. Expect to hear President Draghi  gloat about the recent EURO strength as confirmation of the Draghi QE policy (take that Weidmann). Boockvar has commented in many places that Draghi will use his recently announced appearance at Jackson Hole in late August to suggest a plan for ECB tapering. I am not convinced of this, especially if the EURO CONTINUES IT RECENT RALLY. A strong euro will not benefit the growth stories taking place in the European peripheries. BUT I AM CERTAIN THERE WILL BE NO SENSE OF TAPERING AT TOMORROW’S PRESS CONFERENCE.

Draghi will certainly wait until the FOMC announces its plans before embarking on any change in the ECB‘s balance sheet. Be patient and wait for the press conference to trade as the algo headline readers will be causing chaos for the sake of chaos. To keep all of our readers up to date: The ECB has purchased 33.5 billion of assets as of last Friday’s close. I’m not sure how much they have bought this week but with the strength in the European bonds for the last few days there’s no doubt the ECB has been active in pursuing its monthly target. The biggest change that the ECB could make is that it would begin purchasing EUROPEAN EQUITIES because there are not enough high-quality BONDS to purchase, especially in regards to German sovereign debt. The BOJ buys Japanese equities as well as JGBs, so again that is a move that Draghi could use to provide more firepower to the ECB. However, this is a very low-PROBABILITY decision but it would have a great deal of impact. Have patience and not rush to trade with the headline-driven algos.



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14 Responses to “Notes From Underground: The BOJ and the ECB Provide the Recipe For … ?????”

  1. David Richards (@djwrichards) Says:

    Even to a third-rate trader like myself, it is apparent that no matter the central banks, EURUSD will continue lower (subject to occasional dollar short squeezes like perhaps now) because it’s the path that causes the most pain, which is what markets do. Reminiscent of the gold longs of 3-5 years ago who wouldn’t accept that market sentiment had flipped, fundamentals be damned (recall that even QE-infinity never supported gold; in fact gold ultimately plunged on QE3). Despite a half-year of dollar carnage, I haven’t yet heard one single big-name trader pound the bearish dollar table like they were pounding the long dollar table at New Years… so seems to me it’s still far from over. Disclosure: I remain long currencies and my EURUSD target is 1.28+ and I expect DXY will go below 80 next year as most currencies should gain against the sad-sack dollar. Cuz dollar bear market dude.

  2. David Richards (@djwrichards) Says:

    US jobless claims sink 15,000; ECB Draghi states substantial accommodation is still needed, pledges to boost stimulus and leave door open to even increasing accommodation, and emphasizes that “last thing the ECB wants is tighter financial conditions”. EURUSD rockets up 108 pips in a half-a hour anyway. Sentiment has shifted. CB talk doesn’t impact much; Fed talks hawkish and dollar tumbles; ECB talks dovish and Euro soars. Dollar bear market dude.

    • yra harris Says:

      David–nice reflections and of course this is how the market needs to test itself —its job is to make us all miserable hour to hour and then some and I know you meant dollar lower–many are dazed and confused and Draghi was UBER dovish from so many different directions

  3. David Richards (@djwrichards) Says:

    I can’t imagine anyone not dazed by today’s Euro price action.

    In addition to the dovish ECB, the US data today was decent while EU data disappointed. And the last data released an hour-plus ago: US LEI outperformed at 0.6 against 0.2 prior while EUR confidence crashed -1.7 …and the result?… Euro soars more and is currently up an incrediible 150+ pips since this morning.

    So now add the plunging dollar to the list of reasons in Alexander’s piece about why the Fed can/should bring forward the QT.

    • David Richards (@djwrichards) Says:

      Sadly, I hasten to add the Fed won’t QT in July. They’ve lost their wee bit of mojo… to draghi of all people (who doesn’t even want it). lol. Good job at comic relief, mario & janet, ensuring you won’t raise market volatility; we couldn’t make up funnier stuff if we tried. I’m out. Good night from singapore!

  4. GreenAB Says:

    To me the EUR-USD is acting logically. It´s not about interest differences, it´s the trend of central banks action.

    The US is in tightening mode, the FEDs balance sheet reduction looms. Meanwhile in the ECB isn´t slowing down.

    So where do i want to have my (fixed income) capital? In the US where 300-600b a year might run off the FEDs balance sheet? Or in Europe, where the ECB is still getting in front of the market, keeping a bid under prices?

    Interest differences will matter at some point in the future again. But as long as nobody knows what the balance sheet reduction will do to asset prices, i´d rather be out of the dollar.

    What Draghi doesn´t realize is, that in order let the Euro weaken he has to get HAWKISH.

    • David Richards (@djwrichards) Says:

      Thing is, lately nobody believes the Fed will tighten anymore and the ECB won’t tighten. Plus, opposite to before, the EU is politically stable while the US is hopeless… that’s the perception.

      As for a fixed income strategy, you could join the legions in a short vol strategy. It has worked for years so what could go wrong?…lol

      • GreenAB Says:

        Maybe the FED won´t raise rates. But “…So while the Fed pauses for the next opportunity to raise rates, about two-thirds of economists say the central bank is expected to announce the course of action it will take to unwind its massive bonds portfolio in September…”

        No one knows how QT will look like and which effect it will have on asset prices. My point is – this uncertainty translates into Dollar weakness.

    • Yra Says:

      Green AB–as usual a thoughtful and provocative reply.I am thinking this through and look to respond when I have a trade concept

  5. ShockedToFindGambling Says:

    IMO, the EURO is the junk bond of currencies.

    If the world economy ever turns down, the EURO will tank, as everyone ties to get their money out of Europe, before the currency implodes. The DAX break is a good reason to reconsider long EURO positions.

    The EURO rally is part of what I like to call “The New Abnormal”.

  6. Chicken Says:

    I’m still not comprehending why the euro is in rally mode but I accept it as a fact. Somehow Yra knew and that alone probably saved me from myself.

    Who knows, move the goal posts and sell the news?

    • Yra Says:

      Chicken–you raise the most salient point of all –it is not always what you make but what you keep.In attempting to open a business as an analyst I have to confront how much did you make–the greed side of the equation when sometimes as I stress it is how much did I prevent you from losing which of course many people are only interested in when fear sets in—if done correctly good analysis minimizes FEAR

  7. Recoba Bacci Says:

    Hi guys, If you believed that DXY finds a bottom this year and spends 2018-2019 rallying >120, what do you think would be the optimum way to play this? Im looking for second and third order effects rather than just going long DXY. So far I’ve got:
    1) Sell oil for possible breakdown to $20 if it hasn’t already happened by then-> Short shale oil producers->Sell EM debt of oil nations

    Thanks for any ideas

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