Big Day #1

At last, big day #1 has arrived.  Ever since Draghi dropped the big hint on October 22nd, today has been eagerly awaited by punters and analysts alike.  It's hard to believe that EUR/USD was above 1.13 to start that day; it feels like it's been sub 1.10 for a lot longer than that.

Following on from yesterday's post, Macro Man has been somewhat bemused by the price action  ahead of the ECB, but he probably shouldn't have been.  Fixed income has been rock solid, the euro has remained close to its lows despite some indifferent news flow, and the equity market has had a bit of a pullback.

If we compare the normalized cumulative moves (using 2014 volatilities) in these three assets, we find that Eurozone equities have been the worst performer of the three, and not just because of the August-September Chinageddon.

 

Markets generally like to back a winner, but even more so as the end of the year approaches and the race to get paid is on.   For better or for worse, European equities are looking primarily like a value play at the moment, and that apparently is just not sexy enough for Santa.

Because the ECB is far from a monolithic institutions, it's always difficult to know what to do with "sources" stories, since there are so many potential...errr....sources.  Back in the old days when you'd see a few hundred thousand euribor options go through an hour before the "sources" story hit the tape, you could have a pretty good idea that the source was close to the top.   These days, who knows.

Regardless, the story yesterday that the staff would make only minor (some might say trivial)  adjustments to their forecasts would certainly appear to call into question the scope for dramatic further easing.   After all, if the outlook hasn't changed dramatically, why wheel out the bazooka?  This was also the general tone of the earlier story that was referenced in yesterday's post.

If we look at spot inflation dynamics, we also find little rationale for additional easing.   Yes, the headline inflation rate is close to zero, but a goodly portion of that is energy; ex-energy CPI is 1.0%, up from 0.5% 18 months ago.



Importantly, the recovery in prices has broadened.  At the beginning of the year, only 7 of the 12  major expenditure categories had positive y/y price changes; now, 9 do.   The chart of the median CPI of these categories clearly seems to suggest something of a turning point vis-a-vis underlying price dynamics.



Throw in some more favourable energy base effects moving forwards, and it's easy to see headline CPI snapping back in H1 next year.  No doubt the Germanic contingent of the ECB is thinking that this is exactly what's going to happen.  So, too, may Draghi for all we know.   But Super Mario has proven to be nothing if not a master pragmatist, and having essentially promised action in October, he'll be keen to deliver today.   If it pours gas on  a nascent fire, so much the better for ensuring recovery.

As noted yesterday, however, Macro Man cannot shake the concern that there will be some disappointment.   So credible has Draghi become that it seems that few are even prepared to contemplate an outcome other than over-delivering (having under-promised via these recent 'sources' stories?)  Those of us who were heavily long the European short end in the first half of 2013 can certainly recall a period when Draghi did not over-deliver, though of course that's ancient history.

But when he sees broker notes suggesting that a 2-3 big figure drop in EUR/USD today is a likely outcome, Macro Man gets nervous.   Throw in the Fed saying the sorts of things that they should have been saying two years ago, and he gets even more so.   He remains small short EUR, but has to concede that if he had a bigger position he'd be sweating...and looking for some longer dated low delta upside as a hedge.