Mario Draghi is on deck Thursday morning and market expectations could scarcely be higher. In fact, Draghi is widely expected to execute the Keynesian trifecta, i) a rate cut, ii) expansion of QE, and iii) extension of QE duration.
For better or worse, the ECB has gained a reputation of over-delivering and that means, as Bloomberg put it earlier this week [17], Draghi cannot back down now.
So what, precisely is everyone pricing in, you ask? Well that’s difficult to say. That is, it’s never really clear what’s “priced in” and what isn’t until after the fact, but as Credit Agricole notes, the market generally expects a PSPP extension of six months, a PSPP expansion of €15-20 billion in monthly purchases, and a depo cut of 10 or 20 bps. Anything short of those estimates is “hawkish” we suppose (how absurd is that?) and anything beyond that will be enough to make the Riksbank, the SNB, the Nationalbank, and the Norges Bank nauseous.
The market will also be watching to see if the ECB intends to introduce a two-tiered NIRP application regime which, if implemented, should give Draghi more room on the depo rate and may also ease the extent to which what the ECB does has an outsized effect on the EURCHF cross versus other pairs.
Speaking of deleterious NIRP effects, euro area banks are starting to get nervous about the persistent NIRP erosion. For his part, Peter Garnry, head of equity strategy at Saxo Bank, in Copenhagen, says stay the hell away from banking stocks. "Loose monetary policy, weaker euro stimulate exporters and consumer-related sectors, but banks’ net interest margins are squeezed," Garny says, addint that the "sector faces very negative rate environment, increased competition, and rising regulatory pressure." Most at risk are: Commerzbank, BBVA, Banco Santander, Barclays, StanChart. "Banking stocks should be avoided at all costs," he warns. Echoing that sentiment is Morgan Stanley ("Worry that ECB policy may squeeze the banks again because a negative deposit rate is a tax on banks; QE has often led to compression in net interest rate margins"), Deutsche Bank ("Material medium-term NIM pressures are inevitable in the context of lower-for-longer rates, especially for Germany, Italy and Belgium), and SocGen ("With more ECB easing, stagnant revenue environment would increase need to look for other drivers of earnings"). The following pie chart from Citi should give you an idea of which MFIs suffer the most under the NIRP regime:
In addition to expansion, extension, and the depo cut, observers will also be interested to see if Draghi makes any changes to the list of eligible paper.
Obviously this is a tall order, and as SocGen put it this morning, "with high expectations comes a high risk of disappointment." "The high bar set by expectations, coupled with notable opposition against aggressive action on the Governing Council as economic data developed largely as expected, creates a risk that the ECB will under-deliver," MNI wrote earlier this week. Consider the following from Credit Agricole:
The more important point here is that the Governing Council may struggle to exceed the overly dovish market expectations. Indeed, our recent discussions with a number of clients from the leveraged and the real money community suggested that investors are going into the meeting holding short-EUR positions with many expecting Draghi to over-deliver. According to some, the ECB is trying to replicate the BoJ experience of triggering a massive FX depreciation that will help reignite Eurozone's headline inflation.
We disagree. For a start, we note that the Governing Council's focus has now shifted from lifting headline towards boosting core inflation. According to the ECB's own estimates, the pass through effect from FX depreciation to core inflation should start to manifest itself only after two years and can take up to three years to play out in full. Any policy that targets core inflation gains is taking into account the considerable lag between the policy implementation and the economic outcome. In addition, the policy makers are also conscious of the impact of other drivers like the still sizeable output gap in the Eurozone as well as external factors like the ongoing global currency wars and the gradual Fed tightening cycle expected to start on December 16.
Here's Deutsche Bank's best effort at explaining what's priced in:
[18]
And here's Citi's take on what the options are in terms of various combinations of increased purchases and program duration extension (the blue boxes represent Citi's baselines):
As for how to trade this mad rush further into the Keynesian Twilight Zone (because that's what it will be, even if Draghi does under-deliver) Bloomberg notes that EUR may drop below its March 16 low of 1.0458 should the ECB exceed mkt expectations on more monetary stimulus expansion today; currency could test 21-DMA at 1.0681 if the central bank meets expectations or short-squeeze toward 1.0830 Nov. 12 high on any hawkish surprise from Draghi." Here's the full cheat sheet:
- Positioning, according to three traders in London and one in southern Europe:
- Interbank and leveraged names go short into meeting, real money names may need to chase price action lower
- Bids at 1.0500/10, 1.0450/55, 1.0320/30
- Offers at 1.0640, 1.0720, 1.0800/20
- Large 1.05 and 1.04 barriers protection
- Expiries
- 1.04 (EU1.85b), 1.0450 (EU1.79b), 1.05 (EU3.77b)
- 1.06 (EU2.78b), 1.0650 (EU1.48b), 1.07 (EU1.39b)
- Support
- 1.0500
- 1.0458 March 16 low
- 1.0336/42 Jan. 2/3 2003 double-bottom
- Resistance
- 1.0681 21-DMA
- 1.0764 daily trendline since Oct. 23
- 1.0830 Nov. 12 high
Finally, for anyone curious as to where Draghi's former employer sees the EUR going, Goldman says a "dovish surprise" will drive the euro down to about a 12-year low of $1.03.
That concludes your full Draghi bazooka preview. Trade accordingly.
