The ECB is Trying to Control QE Reaction

• The ECB is Trying to Minimize QE Reaction
• CAD Crashes After Bank of Canada Cuts Rates
• NZD Shrugs Off Rise in PMI
• AUD Crushed by Fear that RBA will Ease
• GBP Hit by Dovish BoE Minutes
• USD/JPY Tanks on BoJ Decision

The ECB is Trying to Control QE Reaction

It is no secret that central banks hate volatility.  Whenever possible, they will go out their way to minimize the market's reaction to big changes in monetary policy. The European Central Bank is known for preparing the market for these changes by sending a consistent message to investors through speeches from policymakers.  We know that most ECB officials believe that it is time to send a strong signal to the market through large-scale asset purchases and today's leaked proposal will most likely turn out to be an attempt to prepare investors for the historic announcement by controlling their reaction. According to Bloomberg who cites "two euro-area central bank officials," the ECB plans to spend 50 billion euros a month on government bond purchases through December 2016 in a program that would exceed 1 trillion euros and if they are right, the program would be large enough to send stocks higher and the euro lower. The problem is that the Wall Street Journal, who cite "sources close to the matter" believe that the program will be more open-ended with the ECB pledging to buy EUR50 billion every month for at least the next year. This goes to show how complicated the decision really is and how many components the ECB needs to consider.  500 billion euros is the number to beat - anything smaller than that should lead to a short squeeze in EUR/USD. The larger the program the greater the pressure that it puts on the currency. Based on the latest CFTC report and the recent price action in EUR/USD, we know that most traders remain short going into the European Central Bank rate decision. Smart traders should consider covering part of their shorts ahead of the ECB announcement because with the bar set high, there is significant risk of disappointment.  A QE announcement will most likely be made during the 8:30am ET / 13:30 press conference and not the 7:45am ET interest rate announcement.   In addition to the size of the program, investors will also be scrutinizing the scope of the ECB's purchases. How much of each sovereign bond will the ECB purchases, how will the risk be shared and will there be a minimum investment grade threshold to avoid purchases of Greek debt?  With so many questions to be answered, it may be best to wait for the ECB announcement before trading the EUR/USD.

CAD Crashes After Bank of Canada Cuts Rates

The Bank of Canada surprised the market with a 25bp rate cut that sent the Canadian dollar sharply lower.  With oil prices falling another 30% since the December meeting, the central bank felt that they could no longer sit on the sidelines and hope that U.S. growth would pick up the slack.  According to the BoC, "the magnitude of oil shock creates exceptional uncertainty" and in response, they lowered their 2015 and 2016 growth and inflation forecasts.  As a result of this decline, they expect a 30% cut to oil and gas investment this year, lower incomes, public finances and job losses.  Their decision to cut rates was a "one-time move" designed to "provide insurance" against lower growth but "if the world changes again, the Bank could take out more insurance."  The prospect of weaker economic reports and their dovish bias should translate into a stronger rally for USD/CAD that could send the currency pair to 1.25. The fear that the Reserve Bank of New Zealand and Reserve Bank of Australia could respond in a similar way drove NZD and AUD sharply lower.  The market is pricing in 2 rate cuts by the RBA this year and while the RBNZ is expected to keep rates on hold, investors are now considering the risk of a less hawkish monetary policy statement next week.  While New Zealand is not immune to the slowdown in global growth, they do not share the same sensitivities to oil as Canada.  Instead, dairy prices are on the rise, which will bode well for New Zealand's economy. The sharp rise in the business PMI index reinforces our more positive outlook on New Zealand versus Canada and our bullish bias for NZD/CAD.

GBP Hit by Dovish BoE Minutes

While the British pound traded lower against the U.S. dollar today on the back of dovish BoE minutes, the limited decline reflects the lack of investment alternatives. The Bank of Canada cut interest rates and the European Central Bank is about to embark on Quantitative Easing.  Even though the two members of the BoE who previously voted for a rate hike voted to keep rates steady at the last meeting, the mere fact that U.K. policymakers are not talking about increasing stimulus is enough to lend support to the currency.  As reported by our colleague Boris Schlossberg, "The release of the BOE minutes surprised the market revealing that the two hawks on the MPC beat a hasty retreat on the issue of rate hikes with the full committee returning to a 9-0 vote to keep rates steady for the time being. Both Martin Weale and Ian McCafferty reversed their votes in light of sharp drop in the inflation data and slowdown in UK economic activity. One of the key concerns for the policy makers was that lower oil prices may become entrenched and keep inflation well below the BoE's 2% target for longer than initially anticipated. More importantly there appears to be no upward pressure from wages in UK. Today's labor data showed that while claimant count continued to improve dropping another -28K average earnings rose 1.7% as expected. UK monetary authorities fear that lower prices at the pump may not necessarily translate into higher demand but rather into further deflationary pressure in which case any tightening would be highly counter productive." 

USD/JPY Tanks on BoJ Decision

There was very little consistency in the performance of the dollar today, which traded lower versus the Japanese Yen and euro and higher versus the commodity currencies.  The sell-off in USD/JPY was driven primarily by the Bank of Japan's decision last night to leave interest rates unchanged and upgrade their growth forecast.  More stimulus from the BoJ and ECB were two of the biggest calls this year and while the BoJ could still ease, their upgraded GDP forecasts diminishes the possibility.  The impact of GDP upgrade should be shortlived as the market remains focused on Fed tightening. The rebound in U.S. yields is supportive for the greenback.  As more central banks ease monetary policy, the hawkish bias of the Fed will make the dollar more attractive to global investors.  Housing starts rebounded today but building permits declined. Jobless claims are scheduled for release on Thursday.