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Chris Weston
ECB Draghi

Draghi gave his most explicit reference to future easing, in what was a carefully constructed statement to portray to the world they are in control. The fact that we saw European 5-year inflation expectations rise by an impressive 9bp to 1.23% speaks volumes on how his comments went above and beyond. Any view that the bank is concerned about tiering the deposit rate (currently -30bp), or taking it deeper into negative territory have been altered, and this was a view shared by Draghi’s spokesman and economist Peter Praet, who spoke shortly after Draghi.

QE is also very much on the cards, and while many felt we were more likely to see asset purchases ahead of rate cuts, from the narrative heard in European trade, we can swap this order of future easing around.

The ECB to cut in September

We saw two-year German bonds fall 7.5 basis points to -76bp, and that tells a clear story in itself. It is incredible that short-end German debt trades at these levels, and to get your head this around takes some doing – who wouldn’t want to issue debt and get paid handsomely to do so? But we can head into the European rates market and see that the market holds the conviction that we get a cut in the September ECB meeting.

Consider that yesterday we saw an absolute collapse in the EU ZEW survey of economic expectations. So, perhaps put the 16 July on the radar, as we get an updated EU ZEW expectations report, and if the ECB measures truly enthuse respondents, it may be seen in a better feel to this survey.


Triggers for a July cut from the Fed

As a timetable, we should see the ECB drop its calendar-based guidance for rate hikes (by the end of 2019) in the 25 July meeting, and do a full 180 turn, indicating that rates are likely to head lower in the period ahead, should more be needed. Of course, we get the July FOMC meeting on 31 July, and should the USD continue its run of form, and we see another weak non-farm payrolls or a poor feel to the G20 meeting in Osaka, then the Fed will embark on a rate cut here.

The ECB will respond and likely cut rates in its 12 September and depending on how financial conditions and inflation expectations play out, we could also see a rate cut and an announcement of QE. That would be a fine way for Draghi to live out his days as ECB president and handover to the incoming president, by effectively pulling out the big guns.

EUR reversals in play

In FX, it was all EUR sellers, although the SEK fared worse as traders asked if the ECB is going down this road, what rabbit will the Swedish Riksbank pull out its hat. EURGBP has pulled back to trend support (seen best on the 4-hour chart), but the pair I put out yesterday was EURNZD, which had broken out and looked so strong. On the daily, price printed a bearish outside day reversal, although we really need the sellers to come in again (and a lower low) through today’s session to confirm a shift in momentum.

EURAUD printed an outside period, closing below the 5-day EMA and again, this is one to watch as AUDUSD has found better buyers, and there is pronounced divergence (between price and the 14-day RSI that could play out).

Trump the currency manipulator

So incensed was Trump at Draghi’s actions that he went after both Draghi and Powell in a Twitter rage. There are just no level playing fields anywhere for Trump right now, and at the heart of this is a Fed governor who won’t play ball. The timing of his tweet, and the news that the Fed have been looking at the legalities of replacing Powell, the day before the FOMC meeting is interesting, but whether this has any bearing on the Fed’s psyche is debatable. If anything, recent comments from the ex-Fed vice chair, Stanley Fischer, would suggest Trump’s directive could see Powell hold off from the dovish turn the market craves. What it tells us though, is Trump wants a lower USD.


The Fed to open the door to a cut

Of course, it’s all eyes on tonight’s FOMC meeting. As detailed, it’s very unlikely we get a cut tonight, if we do the USD will be savaged and US equity indices will likely trade to new highs. It’s not like equities need much encouragement though, as traders feel a currency war is on, and it’s a race to the bottom. I could put a full list of what to watch, but consider the world is so long of short-term bonds and rates that the FOMC needs to bring their A-game or the risk is we will see disappointed.

Consider the interest rate markets have an 82% probability of a cut in the July FOMC, so from a truly simplistic standpoint we need to hear a willingness to act or traders will pile into USDs, and short equities. There seems little doubt that the elephant in the room is the G20 meeting (28 June) though, and while traders got very excited overnight that we are going see a face-to-face meeting between Trump and Xi, backed by a 4% rally in crude. If we don’t see convergence between these two leaders, then the view on the street is the Fed will cut in July.

The period between 4 am, and 5 am AEST, is therefore crucial, and it could be a period where reduced liquidity makes for more erratic moves in price. The risk is we see USD upside, as the bar for disappointment seems elevated. But, in times like these, when the playbook is diverse, we need to go back to trading 101. Managing risk, and understanding how exposures could be impacted by an event very much out of control. So often, in this situation, it can be prudent to reduce risk, and we sleep better. As I wrote in ‘chart of the day’, USDJPY is one to watch, as price is consolidating in a 100-pip range, and is possibly the cleanest vehicle for understanding the reaction to the meeting.

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Chris Weston, Head of Research at Pepperstone

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