EURUSD drop may have further to go given that the relative policy outlook would push Fed/ECB balance sheet ratio lower before long. Citi's Valentin Marinov believes, relative data surprises as well as forward looking cyclical gauges like bank stocks are starting to favor USD over EUR and he points out that leveraged accounts could start adding to shorts again as real money continue to sell EUR.
The clock is ticking on the "Europe is fixed" narrative. It's only a matter of time before the banking crisis resurfaces.
Straightforward dispassionate overview of the investment climate
Earlier today something happened which we haven't seen since a very brief period of time in 2010, and then going all the way back to 2007: Spanish 10 Year bond yields tumbled below those on US 10 Year Treasurys. So is this an indication that the Spanish bond market is suddenly safer, and more credible than that of the US? Of course not. All we are seeing is merely the manifestation of the latest ECB carry trade pushing local banks not to lend the ECB's cheap money out to consumers, but to engage in yet another Draghi-subsidized carry trade.
With the VIX smashing last week to levels not seen since early 2007, the S&P rising to all time highs, and European core and peripheral bond yield this morning touching historic lows, it would appear that the "market" has priced in every possible negative outcome. Which, as Goldman showed over the weekend is clearly not the case at least as investors are concerned who continued to sell stocks across the board in May even as the market broke out to record levels making many wonder who is buying stocks (for more read here)? Expect more of the same, and with some luck we will get a single digit VIX in the coming days as newsflow slows down following payrolls week and ahead of the world cup start in Brazil.
Thumbnail sketch of an overview of next week.
If predicting yesterday's EURUSD (and market) reaction to the ECB announcement was easy enough, today's reaction to the latest "most important ever" nonfarm payrolls number (because remember: with the Fed getting out of market manipulation, if only for now, it is imperative that the economy show it can self-sustain growth on its own even without $85 billion in flow per month, which is why just like the ISM data earlier this week, the degree of "seasonal adjustments" are about to blow everyone away) should be just as obvious: since both bad news and good news remain "risk-on catalysts", and since courtesy of Draghi's latest green light to abuse any and every carry trade all risk assets will the bought the second there is a dip, the "BTFATH mentality" will be alive in well. It certainly was overnight, when the S&P500 rose to new all time highs despite another 0.5% drop in the Shcomp (now barely holding on above 2000), and a slight decline in the Nikkei (holding on just over 15,000).
Goodbye ZIRP, hello NIRP. Today's decision by the ECB to officially lower the deposit facility rate to negative (as in you pay the bank to hold your deposits) is shocking, but not surprising: we previewed just this outcome precisely two years ago in "Europe's "Monetary Twilight Zone" Neutron Bomb: NIRP." Here is what we wrote in June 2012 about Europe's unprecedented NIRP monetary experiment.
Since Mario Draghi is merely a frontman for (and former employee of) Goldman Sachs in yet another central bank, and since his policy mandate is implemented only after extensive drafting and pre-clearance with 200 West, the best "most-mortem" of what happened today comes from the firm that was responsible for today's announcement in the first place: Goldman Sachs itself.
Draghi Reveals More: Will Do Targeted LTRO, Suspends Sterilization, Prepares ABS Purchases; No QE RevealedSubmitted by Tyler Durden on 06/05/2014 08:39 -0400
The much anticipated additional measures have been revealed:
- DRAGHI UNVEILS PACKAGE OF TARGETED LTROS, WORK TO PREPARE QE
- DRAGHI SAYS INITIAL SIZE OF TARGETED LTRO PLAN IS 400BLN EUROS
- ECB EXTENDS FIXED RATE FULL ALLOTMENT, SUSPENDS SMP STERILIZING
- DRAGHI SAYS PACKAGE INCLUDES PREPARATIONS FOR ABS PURCHASES
In other words, even more actions along what was expected: keep in mind the last time the ECB did €1 trillion in LTROs it did exactly nothing to boost inflation or the "real economy." Furthermore, the ABS purchases aren't activated: just being "prepared." However, what was not revealed was the biggest wildcard: European QE, which as we said repeatedly, won't happen until Europe's deflation is far worse, if ever.
In today's abnormally quiet overnight session one could hear a pin, or the USDJPY, drop: with everyone focusing on the ECB announcement in one hour, not a single algo is willing to make any big moves, or even start some momentum ignition, ahead of Draghi's announcement, which absent launching full scale QE, which it won't, will be a disappointment which means the EUR will ultimatly move higher after a kneejerk lower as the market forces Super Mario to do even more next time. As Bloomberg adds, a cut in refi and deposit rates is fully priced in and latest price action suggests investors brace for disappointment if ECB stops short of signaling asset purchases or other liquidity measures to combat deflation.
Monetary policy is diverging in the two largest economies, a trend that is set to shape funding markets for years to come. Before long, these divergent fortunes are bound to lead to large differences in policy. One might expect that movements in financial markets would reflect these expectations. However, so far, by and large, they have not. To my mind, investors should prepare for more volatility this year. A tightening in US monetary policy always causes fallout. This time will be no different. In fact, it may be worse, since the tightening starts from extremely expansionary territory.
As we noted previously, it is likely that whatever Draghi does this week "will not deliver a significant impulse to the real economy" in Europe but while negative rates are almost guaranteed (based on the consensus), reviving the ABS market (via focused QE) is being heralded by many as a positive swing factor. Unfortunately, as SocGen explains, even if the ECB began purchasing ABS in H2 2014, the size and reach of the market is not enough to move the scale as Europe acts desperately to avoid a Japanese-style lost decade.