Trading the ECB QE

This thread is dedicated to information regarding the ECB's potential QE programme and how to best trade it. At this point nobody knows whether we're going to see QE or not, but I think it's best to be prepared as this could be the trade of the year.

UPDATE 24APR14: Since the ECB is slow to react and prefers jawboning to action this thread will likely focus a great deal of attention on the rumors, speeches etc. regarding QE and the trading opportunities that it produces. See this post for more.

A short overview of what has taken place over the past several weeks:
Several central bankers, economists and market participants have been voicing concern over the threat of deflation in the eurozone. During the previous ECB press conference, Mario Draghi made some comments regarding quantitative easing in the eurozone (there were 8 mentions by Draghi, all in all). However, he was very reserved about the matter - he said the matter of QE had been discussed during the governing council meetings, but no decisions had been made. He emphasized the fact that inflation was temporarily subdued arising from a fall in the cost of imported energy. The long term target inflation rate for the ECB is no more but slightly lower than 2%, the recent figures put the inflation rate at 0.5%.

He did not mention any figures regarding QE, but according to FAZ the figure stands at one trillion euros. Draghi has made non-commital comments regarding policy action before, but his results have been mixed. After markets had had time to digest his comments and the most recents NFP figures the jumped on the euro bandwagon to 1.40 and rode it for the entire week. The week was filled with speculation about QE - on the one hand politicians applauding it while damning the expensive euro and on the other hand central bankers denying any concrete commitments regarding EQ. So obviously the markets did what they usually do - they shorted Draghi's words and rode the euro some 200 pips higher against the USD.

During the weekend Draghi visited the IMF in DC, where he once again tried to jaw-bone the euro lower.

Sunday evening/Monday morning saw the euro gap down around 25 pips. The rest of the four-day week was mainly spent in a range between .3800 and .3850 with no real conviction between either side as to where the price should go. To add confusion to the already confusing picture, we got this on Thursday:

Quote

Disliked

The Bundesbank chief, known for his hardline stances at the ECB and as head of the German central bank, is now ready to support such quantitative easing (QE) if he and his ECB colleagues deem it necessary.

This is a new and important development since opposition from Germany has been key in quieting any talk of a potential easing programme similar to what the Fed or BOJ have done. It seems the tide has turned and the Germans are starting to worry about the long term costs of austerity. This is purely speculation on my part but I think they might be fearful of a protracted fall in nominal incomes, which would clearly have a negative impact on debt servicing abilities of the weaker member states.


----------------------- end of intro --

I'm going to keep a keen eye on news out of Europe regarding QE and inflation data. Draghi mentioned the fall in inflation was temporary and attributable to a fall in energy import costs and a late Easter (since when do Christian holidays influence prices?). Draghi and a number of other central bankers and hoping to see inflation figures rise, but with continuing deleveraging in the private sector and a lackluster economy there is no way this is going to happen. Inflation is mostly a monetary phenomenon and you can't have inflation with credit creation hovering around 0%.

You are welcome to add news and commentary regarding this topic and how to perhaps best trade the programme once it's started. However, please remain civil. Trolls and users who post useless comments will be placed on the ignore list without warning.

The ideal conditions for shorting the EURUSD
- pickup in US demand further cementing the need to taper (pent-up demand smashing all expectations following the winter freeze would be especially positive)
- EZ inflation flatlining or falling (ie. negative or next to no net credit creation)
- slow recovery in Europe pointing to no need for additional financing

As far as credit creation is concerned, have a look at these two charts (they're from Feb 2014 but they get the point across, the up-to-date charts aren't that different). The first one displays credit extended to companies by banks, ie the size of the loan portfolio (remember, over 2/3 of financing in the EZ is funded by banks). The second one has the loan portfolio as a % of GDP on the y-axis and the 12 MO change in the size of the loan portfolio on the x-axis. Credit creation plays and important part in inflation and also acts as an indicator of economic activity. Obviously things are pretty bleak.

I pulled the charts from the Bank of Estonia's report, that's why it's in Estonian. Germany is Saksamaa, Eesti is Estonia, euroala is eurozone, Soome is Finland, Rootsi is Sweden. Most of the rest should be pretty straight-forward.

Here is all I could be bothered to dig up from my files...

Some decent stuff from the sell-side on ECB QE (and other interesting things)

Enjoy!

https://catalystresearch.ca-cib.com/...t%40ca-cib.com

https://nexus.nordea.com/#/article/6781

{ copyrighted attachments deleted by staff }

Thank you.

Great thread Bug, awesome E/U chart explanation. This is my currently watched central bank move as I've just started looking for short opportunities on Eur pairs.

Funny I was discussing this subject w/ my trading partner over bfast today and reading this from ZH right before I saw your thread: Everything We Are Told About Deflation Is A Lie

This thrad is dope brah

http://www.dailyfx.com/forex/fundame...-FX-Rates.html

Thanks.

Regarding the ZH link, I have a few comments: The banking system was very different from what it is right now (read about the banking history in the US if interested), but also the economy was very different. The most obvious difference is the economy these days is very dependent on debt and a sustained fall in nominal income will create a recession via debt deflation and the ensuing spiral effect. In fact some people have argued that the recession was as deep as it was precisely because the Fed didn't react fast enough and let nominal incomes fall and create a spiral of debt deflation (see this for more: http://macromarketmusings.blogspot.c...2/what-really-caused-crisis.html). Also, the article claims that there weren't any depressions during the 19th which is a lie. The 19th is littered with depressions and recessions and quite a few of them have to do with a loss of trust in the banks or the money (see this: https://en.wikipedia.org/wiki/List_o..._the_United_States).

Since economic history isn't the main issue of discussion in this thread I will let it rest, however I will point out that it's best to read up on economic history and use sound judgement when reading anything published by ZH. They do have some great content and their Twitter feed can sometimes be quite useful while trading. However, they have their own agenda and anyone who reads their articles needs to keep that in mind (in case it's not clear, their agenda is basically that banks and Keynesians are entirely evil and Hayek/Mises are saints who got everything right). Of course this applies to other news outlets as well, but with ZH you have to be particularly alert.

I've read all of the files posted/linked and looks like most analysts are in a wait and see positions atm. Some reports had very interesting analyses of the potential effects of a QE programme. This was one of them (I've attached the file below):

To be fair, a number of constrains are on the way of ECB unconventional policies (see also ECB sending SOS messages). Past evidence on the effectiveness of negative deposit rates is mixed (see below). Buying sovereign bonds proportionally to the participation of each country in the ECB capital would primarily affect core yields, which are already very low – periphery yields are higher, but have been trending downwards so far this year and have already reached levels that do not threaten debt sustainability in most cases. Buying bank loans is also not straightforward ahead of the bank asset quality review in the Eurozone. And another LTRO scheme likely would be effective only if it reduces substantially the cost for banks (in terms of rate, haircut, or collateral requirements) to avoid the stigma – this would have been ideal to address the ongoing credit crunch in our view, but the ECB is likely to be reluctant to increase its balance sheet exposure to such an extent. Talking the Euro down is also not an easy option, despite recent ECB comments including by Germany’s Weidmann suggesting concerns about the strong Euro. The ECB does not target the exchange rate and, in any case, it would be against the G7’s commitment to flexible exchange rates, particularly taking into account the Eurozone’s record trade surplus. Therefore, the ECB prefers to wait and tackle such constrains only until unconventional policies are almost inevitable.

By knowing the difference between how the banking system operates now and how it operated in times past you can make an educated guess as to how the central bank is going to react to changes in the real economy arising from a protracted period of deflation. However, my comment about deflation regarding the ZH story was mostly to offer some historical perspective and explain a bit what I saw was wrong with the article.

In the current climate I think it's clear that any european central banker who calls for rate hikes, or any kind of monetary tightening would get laughed off the floor.... the meeting on May 8 therefore is most likely going to see an unopposed dovish policy shift.

For now I am ignoring any eur buy signals because of this, I don't want to hold any euro going into May 8 - I am starting to take eur shorts against anything which looks strong.

It still remains to be seen whether Draghi and the governing council will make a real decision or err on the side of caution and stick to jawboning (funny thing the ECB, they err on the side of caution when dovish action is needed but are more than welcome to pull the brakes preemptively when policy is getting too loose). So far they've not paid any attention to relative policy tightness and I think someone should fly a banner on a hot air balloon near the ECB's HQ in Frankfurt with the chart of Taylor rule vs ECB policy rates. In any case I agree with you that now is not the time to take long term positions. I would even avoid shorting on account of potentially surprising US economic releases pushing the pair even higher (though 1.40 seems to be the proverbial ceiling atm).

Wait and see it is.

Not much going on on the news front regarding ECB QE, hence the wait-and-see attitude of the EURUSD pair. This has squeezed fiber into a tight range roughly between 1.3790-95 and 1.3845-50 (first chart). This has provided quite a few opportunities to trade the news (all the other charts). I've compiled a few charts depicting the action on today and yesterday. This range is going to hold until something breaks, but until it does it is set to provide further trading opportunities. Just don't buy at the top and sell at the bottom, I guess.

Let me know if the charts become boring and I'll just stop posting them.

Wednesday:

This morning (link to Draghi story)

This afternoon:

Next week is going to be extremely busy for the euro-dollar pair. We've got the eurozone CPI, M3 money supply, German and French retail sales data releases coming up. Things are much busier on the dollar front - GDP, FOMC, NFP all during the same week! Also, we've got ADP NFP, Chicago PMI and ISM manufacturing PMI and consumer confidence figures coming up! The following week definitely has plenty of potential to break the narrow trading range we've been confined to during the last two weeks.

If you have any thoughts you'd like to share then please go ahead. I don't want this to turn into a single poster thread (I'll probably just stop posting if that happens).

Please carry on. I'm actively reading!

Nice discussion, bug. You very neatly show that the EUR is a political currency and the Fundamentals are paramount.

Hppy Trading!

There are some good PA setups for buying the Euro at the moment and none that I can see for shorting it. So I'm doing... nothing! Very interesting thread.

Hi.
I have here some important headlines that went around today:
ECB'S DRAGHI SEES CONTINUED PROBLEM OF LOW INFLATION IN THE EURO ZONE, QUANTITATIVE EASING IS STILL A WAY OFF – SOURCE
ECB'S DRAGHI SEES NO DEFLATION SCENARIO- SOURCE

This surprising had little effect on EUR/USD, I'm not sure why but could be because market is not believing this sources? since last times 'sources' come out with news that were not true.

Here is how I think it will playout:
Inflation will beat expectations tomorrow on Germany and that will set up the currency bullish move. With a beat on consesus on 30 of april enough to market price in no action for the ECB and if the beat is big enough it could price in a bottom for EZ inflation.

I belive we will be trading close to 1.40 and even 1.40 will be a conservative target going into ECB meeting 8 of may. I'm assuming Eur\Usd is not pricing any ECB QE as for now, but peripheral yields could be pricing in some QE, so it will be good to see how it will react on inflation readings

John, the inflation data is really important and will set the tone for intraday moves but I don't see the ECB having the will to act any time soon. I see them taking action June the earliest, because some members are still wary of large scale asset purchases and the council wants to see the baseline effect removed from a year ago (which itself means they have to wait a month or two for new data, to 'remove' the Easter effect as they said so themselves).

Euro’s resilience is caused by rising short-end real yields and net FDI and portfolio investment inflows. To fight these currents the ECB would have to engage in massive unsterilized foreign bond buying.

Also important. The ECB has no maximum employment mandate which means a greater degree of flexibility. Moreover, consumer price inflation has a tendency to lag economic growth measured in real GDP by several quarters, so calling for QE is premature. Growth is also expected to be around trend among trade partners going forward which reduces the need for extraordinary measures.

EURUSD is only likely to depreciate when FOMC stops pinning down the short-end with its forward guidance. The difficult part is guessing on ‘when’ because FOMC now seems to be inhabited almost completely by doves.

Chart: EURUSD spot w. 2-year real yield spread